Accounting Practice Problems and Solutions

Accounting coursework is tested less by definitions than by whether a set of raw transactions can be turned into a correct, balanced set of financial statements. This page works through that process in full, using a single hypothetical company to keep every figure traceable from the original transaction through to the finished income statement, statement of owner's equity, balance sheet, and cash flow statement, and then moves into shorter, self-contained problems on the specific areas – inventory, depreciation, receivables, liabilities, and corporate equity – that generate the most practice questions on their own.

Introduction to Financial Statements

Four statements make up the core output of the accounting process. The income statement reports revenues and expenses for a period, arriving at net income. The statement of owner's or stockholders' equity shows how ownership claims changed over that same period – profit retained, losses absorbed, owner contributions or dividends paid out. The balance sheet reports assets, liabilities, and equity at a single date, not across a period. The statement of cash flows reports how cash actually moved across operating, investing, and financing activities during the period. The U.S. Securities and Exchange Commission's investor guide states the distinctions directly: "balance sheets show what a company owns and what it owes at a fixed point in time," while "an income statement is a report that shows how much revenue a company earned over a specific time period," and "cash flow statements report a company's inflows and outflows of cash" (U.S. Securities and Exchange Commission, checked 2026-09-29). Every problem below builds toward one or more of these four reports.

The Accounting Equation and Double-Entry Bookkeeping

Every transaction must preserve the equation assets equal liabilities plus owner's equity. Double-entry bookkeeping enforces that balance mechanically: each transaction affects at least two accounts, and the total debits recorded must equal the total credits. Assets, expenses, and losses increase with debits and decrease with credits; liabilities, revenue, and gains increase with credits and decrease with debits. Recording flows through a defined chain – the chart of accounts assigns each account a category, the journal captures the original entry, the ledger organizes entries by account, and the trial balance totals every account to confirm debits still equal credits before statements are prepared.

Practice question. A company purchases equipment by signing a note payable rather than paying cash. What happens to total assets?

Solution. Total assets increase. The equipment is recorded as a new asset at its cost, and the offsetting note payable increases liabilities by the same amount, so the equation stays in balance even though no cash changed hands.

Accrual Basis Versus Cash Basis

Accrual accounting recognizes revenue when it is earned – when goods or services are actually provided – not when cash is collected, and recognizes expenses when the related asset is used or the service is received, not when cash is paid. Cash-basis accounting instead recognizes revenue only when cash is collected. This distinction is one of the most common sources of practice-problem error: a question that states cash collected during the period is testing whether the reader will mistakenly treat that figure as revenue, when the accrual-based revenue figure may be higher or lower depending on what was earned but not yet collected, or collected but not yet earned.

Practice question. A company provides services worth a fixed amount in December but does not collect cash from the client until January. Under accrual accounting, in which month is the revenue recorded?

Solution. December. Revenue is recognized when it is earned – when the service is actually provided – regardless of when the cash arrives. The January collection reduces accounts receivable and increases cash; it does not create new revenue.

Worked Example: Building a Full Statement Set From Transaction Data

Consider a hypothetical company, Thornfield Bookkeeping Services, a sole proprietorship in its first year of operation. The owner invests $30,000 cash to start the business. During the year, the firm earns $70,000 in cash from clients paying at the time of service, and $50,000 in revenue from clients billed on account, of which $25,000 is collected in cash by year end, leaving $25,000 in accounts receivable. Total revenue for the year is therefore $120,000, recognized under accrual accounting as it was earned, not as cash was collected.

The firm buys equipment for $36,000 cash at the start of the year, useful life six years, no salvage value, depreciated straight-line – $6,000 of depreciation expense for the year, leaving $30,000 of net book value at year end. Cash expenses for the year are salaries of $40,000, rent of $18,000, and utilities of $6,000. Office supplies are purchased on account for $4,000 and fully used during the year, leaving $4,000 in accounts payable, unpaid at year end. The owner withdraws $20,000 cash during the year for personal use.

Income statement. Total revenue of $120,000 less salaries ($40,000), rent ($18,000), utilities ($6,000), supplies expense ($4,000), and depreciation expense ($6,000) – total expenses of $74,000 – leaves net income of $46,000 for the year.

Statement of owner's equity. Beginning capital of $30,000 (the owner's initial investment) plus net income of $46,000 less owner drawings of $20,000 equals ending capital of $56,000.

Balance sheet. Cash of $5,000, accounts receivable of $25,000, and equipment at net book value of $30,000 bring total assets to $60,000. Accounts payable of $4,000 is the only liability. Owner's capital of $56,000, carried forward from the statement of owner's equity, completes the other side: $4,000 plus $56,000 equals the $60,000 in total assets, so the statement balances.

Statement of cash flows. Operating activities: cash received from customers of $95,000 ($70,000 cash sales plus $25,000 collected on account) less cash paid for salaries, rent, and utilities of $64,000 gives net operating cash flow of $31,000. Depreciation and the unpaid supplies expense involve no cash movement and are excluded from this section entirely. Investing activities: the $36,000 cash purchase of equipment is a cash outflow. Financing activities: the owner's $30,000 investment less $20,000 in drawings gives net financing cash flow of $10,000. Net cash flow for the year is $31,000 minus $36,000 plus $10,000, equal to $5,000 – which matches the $5,000 cash balance on the balance sheet, since the business started the year with no cash at all.

This is the sequence every larger problem set repeats: record transactions accurately, respect the accrual rules for what counts as revenue and expense, and let the four statements tie back to each other through net income flowing into equity and ending cash flowing into the balance sheet.

The Recording Process and the Accounting Cycle

Behind the finished statements sits a repeatable cycle: journal entries are created for each transaction, posted to the ledger, and summarized as account balances in a trial balance. Adjusting entries then update the accounts for items that accrue or defer across period boundaries – earned but unbilled revenue, incurred but unpaid expenses, prepaid amounts partially used up – and for any errors found before statements are finalized. An adjusted trial balance follows, often built on a worksheet that lines up the unadjusted balances, the adjustments, and the resulting statement figures side by side. Financial statements are then prepared from that adjusted trial balance, closing entries reset temporary accounts (revenue, expense, and drawing accounts) to zero for the next period, and a post-closing trial balance confirms the permanent accounts are still in balance heading into the new period. Reversing entries, used for certain accruals, simplify the following period's routine entries by undoing specific adjusting entries at the start of the new period.

Notes, Principles, and Audit Credibility

A finished set of statements is only as useful as a reader's confidence that the numbers are honest and consistently prepared. The notes accompanying the statements typically begin by disclosing the accounting principles the company followed, along with additional detail on significant asset and liability balances that the face of the statements summarizes but does not fully explain. Preparing the statements is management's responsibility, not the auditor's; an audit opinion states whether the statements are free of material misstatement in accordance with the applicable framework, which lends credibility to the figures without claiming the kind of absolute, transaction-by-transaction certainty that no audit actually provides.

Accounting Standards and Regulatory Bodies

In the United States, the Financial Accounting Standards Board develops generally accepted accounting principles, and its authority is not self-declared – the SEC has formally recognized FASB's standards as "generally accepted" for federal securities law purposes, stating that FASB's pronouncements "have been treated as 'authoritative'" since the board's formation and that "registrants are required to continue to comply with those standards in preparing financial statements filed with the Commission" (U.S. Securities and Exchange Commission, checked 2026-09-29). GAAP itself is not a matter of law by default – it becomes enforceable for a public company specifically because the SEC has adopted it as the standard those companies must follow when filing. Other bodies cover adjacent territory: the Governmental Accounting Standards Board (GASB) sets standards for state and local governments, and the Federal Accounting Standards Advisory Board (FASAB) does the same for federal entities, each operating in its own sector rather than overlapping with FASB's private-sector scope.

Inventory and Cost of Goods Sold

Inventory is a current asset, and cost of goods sold is the cost of the inventory actually provided to customers during the period. Companies use either a periodic system, updating inventory records at fixed intervals, or a perpetual system, updating them after every transaction. Because identical units purchased at different times often cost different amounts, a cost-flow assumption is needed to decide which cost attaches to a unit sold: specific identification tracks the actual cost of each individual unit, weighted average blends all available costs into a single per-unit figure, first-in-first-out (FIFO) assumes the oldest costs are sold first, and last-in-first-out (LIFO) assumes the newest costs are sold first.

Practice problem (hypothetical figures). A company begins the period with 100 units of inventory at $10 each, then purchases 100 more units at $12 each. It sells 150 units during the period. Under FIFO, cost of goods sold uses the oldest cost layer first: 100 units at $10 plus 50 units at $12, for a total of $1,600, leaving 50 units at $12, or $600, in ending inventory. Under LIFO, cost of goods sold uses the newest layer first: 100 units at $12 plus 50 units at $10, for a total of $1,700, leaving 50 units at $10, or $500, in ending inventory. The same 150 units sold produce a $100 difference in reported cost of goods sold purely from the costing method chosen, which is exactly why the method is disclosed in the notes.

Inventory is also written down when its net realizable value falls below its recorded cost – the lower-of-cost-or-net-realizable-value rule – so that obsolete or damaged stock is not carried on the balance sheet above what it could actually be sold for.

Property, Plant, and Equipment and Depreciation

A purchase is capitalized as an asset, rather than expensed immediately, when it is expected to provide benefit beyond the current period. Once capitalized, its cost is allocated across its useful life through depreciation, using straight-line, an accelerated method, or units-of-production, depending on which pattern best matches how the asset is actually used up. The straight-line calculation from the Thornfield example above – cost less salvage value, divided by useful life – is the simplest version; accelerated methods front-load more depreciation into the earlier years, and units-of-production ties the expense to actual usage rather than the passage of time.

Practice problem (hypothetical figures). A hypothetical company buys a machine for $50,000 with an estimated salvage value of $5,000 and a ten-year useful life. Straight-line annual depreciation is cost minus salvage, divided by useful life: $50,000 minus $5,000, divided by ten years, equals $4,500 per year. After four full years, accumulated depreciation is $18,000, leaving a net book value of $32,000.

When an asset is later sold, retired, or exchanged, any difference between the cash or value received and the asset's net book value at that point is recorded as a gain or loss on disposal.

Receivables and Revenue Recognition

Accounts receivable arise whenever revenue is earned before cash is collected, which is the accrual principle applied specifically to sales made on credit. Because some customers will not ultimately pay, companies estimate uncollectible accounts rather than waiting to find out which specific customer defaults. The direct write-off method removes a receivable from the books only once it is confirmed uncollectible; the allowance method instead estimates bad debt expense in the same period the related revenue was recognized, matching the expense to the revenue it helped generate rather than to whichever later period a default happens to be discovered in. An accounts receivable aging analysis, which sorts outstanding balances by how long they have been unpaid, is a common tool for estimating that allowance, since older balances are statistically less likely to be collected than recent ones. Notes receivable – formal, often interest-bearing promises to pay – are tracked separately from ordinary trade receivables, with accrued interest revenue recognized as it is earned across the life of the note, following the same accrual logic as every other revenue figure on this page.

Current and Non-Current Liabilities

Current liabilities include accounts payable, accrued expenses such as unpaid wages or interest, short-term notes payable, and the current portion of any long-term debt. Payroll transactions generate their own recurring set of journal entries – gross wages, withheld taxes, and the employer's own payroll tax obligations all need separate accounts. Product warranties and other contingent obligations are estimated and recorded when the underlying event that creates them (a sale of the warrantied product) has already occurred, even though the exact future payout remains uncertain.

Long-term financing options include notes payable extending beyond a year and bonds payable, which involve their own vocabulary: a bond's face value, its stated interest rate, and the market rate at issuance interact to determine whether the bond sells at a premium or a discount, which is then amortized over the bond's life. Lease obligations, depending on their classification, can create a long-term liability alongside a corresponding right-of-use asset. Time value of money underlies most of this category, since a dollar promised years from now is worth less today than a dollar in hand.

Practice problem (hypothetical figures). A hypothetical company issues a bond with a $100,000 face value at a discount, receiving $95,000 in cash. The $5,000 discount is not an immediate loss; it is amortized as additional interest expense over the bond's remaining life, gradually bringing the liability's carrying value up to the full $100,000 by maturity.

Corporations and Equity Transactions

Forming a corporation creates a distinct legal entity with its own set of equity accounts: common stock, recorded at par or stated value with any excess recorded as additional paid-in capital, and preferred stock, where it exists, carrying different dividend and liquidation rights than common stock does. Treasury stock – a company's own shares bought back rather than retired – reduces total equity and is shown as a contra-equity account rather than as an asset. Dividends declared reduce retained earnings; a stock dividend distributes additional shares rather than cash and reclassifies an amount within equity without changing total equity itself, while a stock split increases the number of shares outstanding and proportionally reduces par value per share without changing total equity or any dollar balance at all. The statement of stockholders' equity tracks all of these movements together across the period, the corporate-form equivalent of the statement of owner's equity used in the Thornfield example above.

Financial Statement Analysis

Once a statement set is finished, ratios convert its raw figures into comparable measures. Liquidity measures include working capital (current assets minus current liabilities), the current ratio (current assets divided by current liabilities), and the quick ratio, which excludes inventory from current assets before dividing by current liabilities. Operating-efficiency measures include inventory turnover and accounts receivable turnover, both signaling how quickly a company converts those assets into cash. Profitability measures include return on assets, return on equity, gross and net profit margin, and earnings per share. Solvency measures include debt-to-equity and debt-to-total-assets, both signaling how much of the business is financed by borrowing rather than ownership.

Applied to the hypothetical Thornfield example above: the current ratio is $30,000 in current assets (cash of $5,000 plus receivables of $25,000) divided by $4,000 in current liabilities, or 7.5 – a very comfortable liquidity position, typical of a small service firm with minimal debt. Return on equity is net income of $46,000 divided by ending equity of $56,000, or roughly 82 percent – an unusually high figure that mainly reflects how small and lightly financed this hypothetical first-year business is, which is exactly why ratios are read against context and peer comparison rather than a fixed universal benchmark.

Practice Questions and Solutions

Fill in the blank. The financial statement that reports assets, liabilities, and equity as of a specific date, rather than over a period, is the ______.

Solution. Balance sheet.

Multiple choice. Which of the following is classified as a financing activity on the statement of cash flows?

a) Cash paid to suppliers b) Cash received from customers c) Cash paid for new equipment d) Cash received from an owner's investment

Solution: d. Financing activities relate to long-term liabilities and owner's or stockholders' equity, which includes an owner's cash investment. Cash paid to suppliers and cash received from customers are operating activities; cash paid for new equipment is an investing activity.

Numerical. A hypothetical company reports beginning retained earnings of $80,000, net income for the period of $30,000, and dividends declared of $10,000. What is ending retained earnings?

Solution. $80,000 plus $30,000 minus $10,000 equals $100,000.

About the Test and Skills Assessed

Accounting and finance assessments, whether built into a course or used by an employer for screening, generally test the same underlying ability: measuring and processing financial information relevant to a business, from basic classification of assets and liabilities through recording transactions in the correct accounts and calculating profit margins from a finished income statement. Roles that draw on this skill set extend beyond staff accountants to financial analysts and risk analysts, all of whom rely on the same statement-building and interpretation skills this page has walked through. Question formats commonly include multiple choice, fill-in-the-blank, numerical problems requiring a calculation shown in full, and multiple-answer items where more than one option can be correct – the same range of formats used in the practice set above.

Where to Go Next

Recognition-format questions on the same topics covered here – assets, liabilities, journal entries, the trial balance – are covered in accounting multiple choice questions. For a full study method built around a cumulative final rather than a single problem set, see accounting final exam prep. Candidates preparing for the CPA Exam, where task-based simulations closely resemble the worked problems on this page, should see the CPA Exam guide. For the rest of this site's exam-prep material, return to the exam prep hub.

If actual graded coursework – not self-testing – needs review from a subject-matched specialist before submission, see financial accounting assignment help.

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