CHAPTER 1 THE FINANCIAL STATEMENTS LEARNING OBJECTIVES 1. Use accounting vocabulary for decision making 2. Apply accounting concepts and principles 3. Use the accounting equation to describe an organization 4. Evaluate a company’s operating performance, financial position, and cash flows 5. Explain the relationships among the financial statements QUESTIONS ON OPENING VIGNETTE 1. The income statement for Yum! Brands’ details the firm’s earned revenues and net income. What is the meaning of these accounting terms? Solution: Revenues are increases in retained earnings from delivering goods and services to customers or clients. Net income is the difference between the revenues earned during the accounting period and the expenses incurred to earn the revenues. (easy, L.O. 1) 2. Who are investors and what information does a potential investor need from Yum! Brands? Solution: Investors (along with creditors) provide money to finance the operations of Yum! Brands. They need relevant and reliable information regarding the amount they can expect to earn from their investment in Yum! Brands. (medium, L.O. 4) TRUE/FALSE QUESTIONS 3. Bookkeeping is a type of accounting used primarily by sole proprietorships. 1-1
Transcript
CHAPTER 1THE FINANCIAL STATEMENTS
LEARNING OBJECTIVES
1. Use accounting vocabulary for decision making2. Apply accounting concepts and principles3. Use the accounting equation to describe an organization4. Evaluate a company’s operating performance, financial position, and cash flows5. Explain the relationships among the financial statements
QUESTIONS ON OPENING VIGNETTE
1. The income statement for Yum! Brands’ details the firm’s earned revenues and net income. What is the meaning of these accounting terms?
Solution:Revenues are increases in retained earnings from delivering goods and services to customers or clients. Net income is the difference between the revenues earned during the accounting period and the expenses incurred to earn the revenues. (easy, L.O. 1)
2. Who are investors and what information does a potential investor need from Yum! Brands?
Solution:Investors (along with creditors) provide money to finance the operations of Yum! Brands. They need relevant and reliable information regarding the amount they can expect to earn from their investment in Yum! Brands.(medium, L.O. 4)
TRUE/FALSE QUESTIONS
3. Bookkeeping is a type of accounting used primarily by sole proprietorships.(medium, L.O. 1, false)
4. The three forms of business organizations are sole proprietorships, partnerships, and not-for-profit organizations.(easy, L.O. 1, false)
5. Relevant and reliable accounting information is required to convince an investor to invest money in a particular company.(easy, L.O. 1, true)
6. All business owners are personally liable for the debts of their businesses.(easy, L.O. 1, false)
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7. From both an accounting and a legal viewpoint, a proprietorship is a distinct and separate entity from the proprietor.(moderate, L.O. 1, false)
8. Generally accepted accounting principles, or GAAP, are the rules and procedures established by the Financial Accounting Standards Board, or the FASB.(easy, L.O. 2, true)
9. The stable monetary unit concept means that the type of currency used for the financial statements is not expected to change.(moderate, L.O. 2, false)
10. The objectivity principle states that assets and services should be recorded at their actual cost, since cost is a reliable measure to use in financial accounting.(moderate, L.O. 2, false)
11. The accounting equation expresses the idea that Resources = Outsider claims + Insider claims.(difficult, L.O. 3, true)
12. The accounting equation must always be in balance.(easy, L.O. 3, true)
13. Liabilities are divided into "outsider claims" and "insider claims."(moderate, L.O. 3, false)
14. Stockholders’ equity is often referred to as "net assets" and represents the residual amount of business assets which can be claimed by the owners.(moderate, L.O. 3, true)
15. Common stock and net income are the main components of paid-in capital.(moderate, L.O. 3, false)
16. Retained earnings represent cash that is available to a company for future operations and expansion.(difficult, L.O. 3, false)
17. Net income appears on both the income statement and the balance sheet.(medium, L.O. 3, false)
18. The statement of retained earnings is organized in terms of the organization’s operating, investing, and financing activities.(medium, L.O. 3, false)
19. Expenses are decreases in retained earnings that result from operations.(moderate, L.O. 3, true)
20. For business purposes, dividend payments are classified as expenses.(moderate, L.O. 3, false)
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21. The computation of ending retained earnings considers current net income or net loss and dividends.(moderate, L.O. 3, true)
22. The owners’ equity of proprietorships and partnerships is different.(medium, L.O. 3, true)
23. The statement of cash flows reports on where cash came from and how it was used.(moderate, L.O. 4, true)
24. In accounting, the word "net" means after a subtraction.(moderate, L.O. 4, true)
25. The owners’ equity of a partnership includes both partner stock and partner earnings.(difficult, L.O. 4, true)
26. A balance sheet reports the company’s financial position at a specific point in time.(medium, L.O. 4, true)
MULTIPLE CHOICE QUESTIONS
27. The two types of accounting are:a. financial and managerialb. internal and externalc. bookkeeping and decision-orientedd. profit and nonprofit(medium, L.O. 1, a)
28. According to the author, potential investors need information that is:a. fair and future-orientedb. accurate and truthfulc. relevant and reliabled. audited and complete(medium, L.O. 1, c)
29. Who ultimately controls a corporation?a. the chief executive officerb. board of directorsc. presidentd. the stockholders (medium, L.O. 1, d)
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30. Financial statements are:a. reports issued by outside consultants who are hired to analyze key operations of the
businessb. reports created by management that states it is responsible for the acts of the
corporationc. standard documents that tell us how well a business is performing and where it
stands in financial termsd. standard documents issued by outside consultants who are hired to analyze key
operations of the business in financial terms(easy, L.O. 1, c)
31. For which form of business ownership are the owners of a business legally distinct from the business?a. proprietorshipb. partnershipc. corporationd. all of the above(easy, L.O. 1, c)
32. All of the following are forms of business organizations except:a. proprietorshipb. partnershipc. restaurantd. corporation(easy, L.O. 1, c)
33. The largest organization of professional accountants in the United States is the:a. American Institute of Certified Public Accountantsb. Securities and Exchange Commissionc. Financial Accounting Standards Boardd. Auditing Standards Board(moderate, L.O. 1, a)
34. The Financial Accounting Standards Board is responsible for establishing:a. the American Institute of Certified Public Accountantsb. the Securities and Exchange Commissionc. generally accepted accounting principlesd. the code of professional conduct for accountants(moderate, L.O. 2, c)
35. The acronym GAAP stands for:a. government audited accounting pronouncementsb. generally accepted accounting principlesc. government authorized accountant principlesd. generally acceptable authorized pronouncements(moderate, L.O. 2, b)
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36. All of the following are characteristics of useful accounting information except:a. relevantb. informativec. consistentd. reliable(moderate, L.O. 2, b)
37. The objectivity principle of accounting:a. maintains that each organization or section of an organization stands apart from other
organizations and individualsb. ensures that accounting records and statements are based on the most reliable data
availablec. holds that the entity will remain in operation for the foreseeable futured. enables accountants to ignore the effect of inflation in the accounting records (moderate, L.O. 2, b)
38. The stable-monetary-unit concept of accounting:a. maintains that each organization or section of an organization stands apart from other
organizations and individualsb. ensures that accounting records and statements are based on the most reliable data
availablec. holds that the entity will remain in operation for the foreseeable futured. enables accountants to ignore the effect of inflation in the accounting records (moderate, L.O. 2, d)
39. The going-concern concept of accounting:a. maintains that each organization or section of an organization stands apart from other
organizations and individualsb. ensures that accounting records and statements are based on the most reliable data
availablec. holds that the entity will remain in operation for the foreseeable futured. enables accountants to ignore the effect of inflation in the accounting records. (moderate, L.O. 2, c)
40. The principle which states that assets acquired by the business should be recorded at their actual price is the:a. objectivity principleb. stable dollar principlec. cost principled. reliability principle(easy, L.O. 2, c)
41. The reliability principle is also called the:a. full and fair principleb. truthfulness conceptc. relevance conceptd. objectivity principle(moderate, L.O. 2, d)
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42. Which of the following statements below is false?a. The informed opinion of owners is an important source of objective evidence.b. Reliable data may be supported by objective evidence.c. An independent appraisal, conducted by a licensed professional, is usually
considered reliable.d. Reliable data are verifiable.(moderate, L.O. 2, a)
43. The relevant measure of value of the assets of a company that is going out of business is its:a. historical costb. recorded valuec. book valued. current market value(moderate, L.O. 2, d)
44. The CEO of a business owns a residence in Phoenix. The company the CEO works for owns a residence in Tucson used for strategic planning meetings by its executives. Which of these properties is considered assets of the business?a. the Phoenix residence onlyb. the Tucson residence onlyc. both the Phoenix and Tucson residencesd. neither the Phoenix nor Tucson residences(moderate, L.O. 2, b)
45. An Oklahoma City business paid $25,000 cash for equipment used in the business. At the time of purchase, the equipment had a list price of $30,000. When the balance sheet was prepared, the value of the equipment later rose to $32,000. What is the relevant measure of the value of the equipment?a. historical cost, $25,000b. fair market cost, $30,000 c. current market cost, $32,000d. $25,000 on the day of purchase, $32,000 on balance sheet date(moderate, L.O. 2, a)
46. The accounting equation can be stated as:a. Assets + Liabilities = Stockholders’ equityb. Assets = Liabilities + Stockholders’ equityc. Assets = Liabilities - Stockholders’ equityd. Assets + Stockholders’ equity = Liabilities(easy, L.O. 3, b)
47. Which of the following best describes a liability?a. Liabilities are a form of paid-in capital.b. Liabilities are future economic benefits to which a company is entitled.c. Liabilities are accounts receivable of the corporation.d. Liabilities are economic obligations to creditors to be paid at some future date by the
corporation.(easy, L.O. 3, d)
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48. The owners’ interest in the assets of a corporation is known as:a. long-term assetsb. stockholders’ equityc. operating expensesd. common stock(moderate, L.O. 3, b)
49. Claims held by the stockholders of a corporation are alternately known as:a. retained earningsb. paid-in capitalc. earned incomed. paid-in capital plus retained earnings(difficult, L.O. 3, d)
50. Payables are classified as:a. increases in earningsb. assetsc. decreases in earningsd. liabilities(easy, L.O. 3, d)
51. Receivables are classified as:a. increases in earningsb. assetsc. decreases in earningsd. liabilities(easy, L.O. 3, b)
52. The sum of "outsider claims" plus "insider claims" equals:a. total assetsb. net incomec. total stockholders’ equityd. total liabilities(difficult, L.O. 3, a)
53. Revenues are:a. increases in liabilities resulting from delivering goods or services to customersb. increases in retained earnings resulting from delivering goods or services to customersc. decreases in assets resulting from delivering goods or services to customersd. decreases in retained earnings resulting from delivering goods or services to customers(moderate, L.O. 3, b)
54. How do revenues for a period relate to the beginning and ending balances in retained earnings?a. Revenues will increase the beginning balance of retained earnings for the period.b. Revenues will decrease the beginning balance of retained earnings for the period.c. Revenues less expenses will either increase or decrease the beginning balance of
retained earnings for the period.
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d. None of these answers are correct.(moderate, L.O. 3, c)
55. Expenses are:a. increases in assets resulting from operationsb. increases in retained earnings resulting from operationsc. increases in liabilities resulting from purchasing assetsd. decreases in retained earnings resulting from operations(moderate, L.O. 3, d)
56. Dividends:a. always affect net incomeb. are distributions to stockholders of assets (usually cash) generated by net incomec. are expensesd. are distributions to stockholders of assets (usually cash) generated by a favorable
balance in retained earnings(moderate, L.O. 3, b)
57. A corporation’s paid-in capital consists ofa. assets and liabilitiesb. revenues and expensesc. net income and dividendsd. common stock and retained earning(moderate, L.O. 3, d)
58. Net income is computed as:a. revenues – expensesb. revenues + expenses c. revenues – expenses + dividendsd. revenues – expenses – dividends(moderate, L.O. 3, a)
59. Which of the following must be added to beginning Retained Earnings to compute ending Retained Earnings?a. revenuesb. expensesc. dividendsd. All of these answers are correct.(moderate, L.O. 3, a)
60. At the end of the current accounting period, account balances were as follows: Cash, $150,000; Accounts Receivable, $50,000; Common Stock, $10,000; Retained Earnings, $60,000. Liabilities for the period were:a. $ 80,000b. $130,000c. $140,000d. $190,000(moderate, L.O. 3, b)
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61. On January 1, 2004, total assets for Liftoff Technologies were $125,000; on December 31, 2004, total assets were $145,000. On January 1, 2004, total liabilities were $110,000; on December 31, 2004, total liabilities were $115,000. What is the amount of the change and the direction of the change in Liftoff Technologies' stockholders’ equity for 2004?a. decrease of $15,000b. increase of $15,000c. increase of $30,000d. decrease of $30,000(moderate, L.O. 3, b)
62. Revenues were $150,000, expenses were $70,000, and cash dividends were $30,000. What was the net income and the change in retained earnings for the period?
Change inNet Retained
Income Earningsa. $50,000 $50,000b. $80,000 $50,000c. $80,000 $80,000d. $250,000 $250,000(moderate, L.O. 3, b)
63. At the beginning of the period assets were $400,000 and stockholders’ equity was $150,000. During the year assets increased by $30,000, liabilities increased by $50,000, and stockholders’ equity was unchanged. Beginning liabilities must have been:a. $230,000b. $250,000c. $280,000d. $300,000(difficult, L.O. 3, b)
64. If assets increase $120,000 during a given period and liabilities decrease $25,000 during the same period, stockholders’ equity must:a. increase $95,000b. decrease $145,000c. decrease $95,000d. increase $145,000(difficult, L.O. 3, d)
65. If liabilities increase $120,000 during a given period and stockholders’ equity decreases $25,000 during the same period, assets must:a. decrease $145,000b. increase $145,000c. increase $95,000d. decrease $95,000(difficult, L.O. 3, c)
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66. Stockholders’ equity for Commerce-GA Corporation on 01/01/2006 and 12/31/2006 were $60,000 and $75,000, respectively. Assets on 01/01/2006 and 12/31/2006 were $115,000 and $105,000, respectively. Liabilities on 01/01/2006 were $55,000. What is the amount of liabilities on 12/31/2006?a. $40,000b. $15,000c. $30,000d. The amount is indeterminable from the given information.(difficult, L.O. 3, c)
67. Dividends appear on the:a. retained earnings statementb. income statementc. balance sheetd. both the retained earnings statement and the income statement(moderate, L.O. 4, a)
68. Assets appear on the:a. balance sheetb. income statementc. retained earnings statementd. statement of cash flows(easy, L.O. 4, a)
69. Common stock appears on the:a. balance sheetb. income statementc. statement of cash flowsd. retained earnings statement(easy, L.O. 4, a)
70. A company’s gross profit for the period is reported on the: a. balance sheetb. statement of cash flowsc. income statementd. statement of retained earnings(easy, L.O. 4, c)
71. Gains and losses appear on which of the financial statements listed below?a. the balance sheetb. the income statementc. the retained earnings statementd. the statement of cash flows(easy, L.O. 4, b)
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72. The ending balance in Retained Earnings appears on the:a. balance sheet onlyb. balance sheet and statement of retained earningsc. statement of retained earnings onlyd. income statement(moderate, L.O. 4, b)
73. Cash dividends:a. decrease revenue on the income statementb. increase expenses on the income statementc. decrease retained earnings on the retained earnings statementd. decrease operating activities on the statement of cash flows(moderate, L.O. 4, c)
74. Which of the following financial statements shows the net increase or decrease in cash during the period?a. balance sheetb. statement of operationsc. statement of retained earningsd. statement of cash flows(easy, L.O. 4, d)
75. An investor wishing to assess a company’s financial position at the end of the period would probably examinea. the statement of cash flowsb. the income statementc. the balance sheetd. the statement of retained earnings(moderate, L.O. 4, c)
76. A potential investor interested in evaluating a company’s financial performance for the current period would probably examine which of the following financial statements?a. balance sheetb. income statementc. statement of cash flowsd. retained earnings statement(moderate, L.O. 4, b)
77. Which statement summarizes the revenues and expenses of an entity?a. balance sheetb. statement of cash flowsc. statement of retained earningsd. statement of operations(moderate, L.O. 4, d)
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78. Which financial statement provides a "snapshot photo" of one moment in time?a. balance sheetb. income statementc. statement of retained earningsd. statement of cash flows(moderate, L.O. 4, a)
79. The income statement:a. reports the results of operations since the inception of the businessb. covers a defined period of timec. is not datedd. may cover a period of time or only one day in time, like a snapshot photograph(moderate, L.O. 4, b)
80. The income statement presents a summary of the:a. revenues and expenses of an entity for a specific time periodb. assets and liabilities of an entityc. cash inflows and outflows of an entityd. changes that occurred in the stockholders’ equity of an entity(easy, L.O. 4, a)
81. Operating expenses appear on the income statement:a. directly after gross profitb. directly after cost of goods soldc. directly after revenued. Operating expenses do not appear on the income statement.(moderate, L.O. 4, a)
82. Cost of goods sold:a. appears on the income statement as a deduction from gross profitb. appears on the balance sheet as a deduction from salesc. appears on the income statement as a deduction from salesd. appears on the retained earnings statement as an addition to beginning retained
earnings(moderate, L.O. 4, c)
83. A retail store buys t-shirts for $25 and sells them for $60. The store’s cost of goods sold would be:a. $25b. $35c. $60d. None of these answers are correct.(easy, L.O. 4, a)
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84. Net income is:a. deducted from beginning retained earnings on the retained earnings statementb. added to beginning retained earnings on the retained earnings statementc. added to assets on the balance sheetd. deducted from net sales on the income statement(moderate, L.O. 4, b)
85. A net loss occurs when:a. total revenues exceed total expensesb. total expenses exceed total revenuesc. total revenues and dividends exceed total expensesd. total revenues exceed total expenses and dividends(moderate, L.O. 4, b)
86. The balance sheet is alternately known as the:a. operating statementb. assets statementc. statement of financial positiond. statement of profit and loss(moderate, L.O. 4, c)
87. The balance sheet reports information about:a. liabilities, equity, and expensesb. assets, revenues, and liabilitiesc. assets, liabilities, and equityd. revenues, expenses, and equity(easy, L.O. 4, c)
88. Assets are generally classified as:a. current assets and producing assetsb. producing assets and consumable assetsc. long-term assets and consumable assetsd. current assets and long-term assets(easy, L.O. 4, d)
89. Current assets are assets expected to be converted to cash, sold, or consumed:a. within the next 12 months or within the business’s normal operating cycle if less
than a yearb. within the next 12 months or within the business’s normal operating cycle if longer
than a yearc. within the next 6 monthsd. within the next 24 months(moderate, L.O. 4, b)
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90. Notes receivable due in 60 days would be classified as a:a. long-term asset on the balance sheetb. current asset on the balance sheetc. current liability on the balance sheetd. long-term liability on the balance sheet(easy, L.O. 4, b)
91. Equipment would appear on the:a. income statement with the revenuesb. balance sheet with the long-term assetsc. balance sheet with the current assetsd. income statement with the operating expenses(easy, L.O. 4, b)
92. Depreciation is normally associated with which asset on the balance sheet?a. landb. accounts receivablec. inventoryd. equipment(moderate, L.O. 4, d)
93. Accounts receivable would appear on the:a. income statement with the revenuesb. retained earnings statement with the net incomec. balance sheet with the current assetsd. balance sheet with the current liabilities(easy, L.O. 4, c)
94. Notes payable (due in 60 days) would appear on the:a. income statement with the expensesb. retained earnings statement with the dividendsc. balance sheet with the current assetsd. balance sheet with the current liabilities(easy, L.O. 4, d)
95. Income taxes owed to the federal government would be classified as a(n):a. current asset on the balance sheetb. current liability on the balance sheetc. expense on the income statementd. financing activity on the statement of cash flows(moderate, L.O. 4, b)
96. Purchases and sales of long-term assets are examples of:a. investing activitiesb. accrual activitiesc. financing activitiesd. operating activities(moderate, L.O. 4, a)
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97. Stockholders’ equity increases as a result of:a. owner investmentsb. a net loss during the periodc. a net income during the periodd. both a and c(moderate, L.O. 4, d)
98. When treasury stock is purchased by a company it:a. increases the amount of owners’ equityb. decreases the amount of owners’ equityc. decreases the amount of total liabilitiesd. increases the amount of total liabilities(difficult, L.O. 4, b)
99. The statement of cash flows is divided into which three categories?a. planning, executing, and evaluating activitiesb. operating, investing, and financing activitiesc. increasing, decreasing, and noncash activitiesd. developing, producing, and marketing activities(easy, L.O. 4, b)
100. What is the proper order for the statement of cash flows?a. financing activities, investing activities, and operating activitiesb. operating activities, investing activities, and financing activitiesc. operating activities, financing activities, and investing activitiesd. investing activities, financing activities, and operating activities(moderate, L.O. 4, b)
101. Cash received from the sale of stock would appear:a. as an operating activity on the statement of cash flowsb. as a noncash financing activity on a statement of cash flowsc. as an investing activity on the statement of cash flowsd. as a financing activity on the statement of cash flows(moderate, L.O. 4, d)
102. The repayment of a note payable would be classified as a(n):a. investing activity on a statement of cash flowsb. financing activity on a statement of cash flowsc. operating activity on a statement of cash flowsd. current asset on the balance sheet(difficult, L.O. 4, b)
103. The issuance of stock for cash would be classified as a(n):a. investing activity on a statement of cash flowsb. financing activity on a statement of cash flowsc. operating activity on a statement of cash flowsd. current asset on the balance sheet(difficult, L.O. 4, b)
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104. Cash collected from customers would appear on the statement of cash flows as a(n):a. operating activityb. financing activityc. investing activityd. activity that would not appear on the statement of cash flows.(moderate, L.O. 4, a)
105. The payment of salaries would appear:a. on the statement of cash flows with the operating activitiesb. on the statement of financial position with the current liabilitiesc. on the statement of earnings with the revenuesd. on the statement of operations as part of cost of goods sold(difficult, L.O. 4, a)
106. The income statement is prepared to determine:a. the change in retained earnings due to the results of operations b. the change in cash due to results of operationsc. the change in assets and liabilities due to the results of operationsd. All of these answers are correct.(difficult, L.O. 5, a)
107. Which of the following statements should be prepared before the balance sheet is prepared?a. statement of retained earnings b. statement of cash flowsc. statement of financial positiond. Both the statements of retained earnings and cash flows are correct.(difficult, L.O. 5, a)
108. The amount of net income shown on the income statement also appears on the:a. balance sheetb. statement of assetsc. statement of financial positiond. statement of retained earnings(moderate, L.O. 5, d)
109. The balance sheet contains:a. the amount of net incomeb. the beginning balance in retained earningsc. the ending balance in retained earningsd. the amount of dividends paid to stockholders(moderate, L.O. 5, c)
110. What is one component of stockholders’ equity?a. common stockb. notes payablec. property, plant, and equipmentd. cash(easy, L.O. 5, a)
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111. Which financial statement must be prepared before the others?a. income statementb. balance sheetc. statement of cash flowsd. retained earnings statement(moderate, L.O. 5, a)
112. The SEC Edgar file contains information on: a. all profitable US companiesb. all companies on the SEC "watch list"c. recommended US and international companiesd. all publicly traded companies in the US(moderate, L.O. 5, d)
113. The main source of cash for a business stems from:a. current assetsb. operating activitiesc. financing activitiesd. investing activities(moderate, L.O. 5, b)
114. Retained earnings appear on which of the following financial statements?a. statement of retained earnings, statement of cash flows, and income statement, but
not the balance sheetb. statement of retained earnings and balance sheet, but not the income statement or
statement of cash flowsc. statement of retained earnings, statement of cash flows, and balance sheet, but not
the income statementd. statement of retained earnings and statement of cash flows, but not the income
statement or balance sheet(difficult, L.O. 5, b)
115. An investor who wished to answer the question, "Can the company sell its products?" should investigate thea. current and projected inventory levelsb. sales revenue trendc. net income for the current period and projected net income for the next periodd. operating activities section of the cash flow statement(moderate, L.O. 5, b)
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PROBLEMS AND CRITICAL THINKING EXERCISES
116. A company’s management makes three major types of decisions on an ongoing basis: decisions regarding operating activities, decisions regarding investing activities, and decisions regarding financing activities. Discuss each of these three types of activities, including examples of each type.
Solution:Operating activities relate to deciding how to operate the business and involve decisions such as what products and/or services to sell, what prices to sell those products and services for, and how to market those products and services. Investing activities relate to deciding what kinds of investments to make and involve decisions such as what types of long-term assets to buy. Financing activities relate to deciding how to finance the company’s operations and involve decisions such as whether to obtain cash by selling stock or by borrowing from a bank.(moderate, L.O. 1)
117. Why is accounting often referred to as "the language of business?" How is accounting different from bookkeeping?
Solution:Accounting is the system that measures business activities, processes that information into reports, and communicates the results to decision makers. Accounting, as an information system, provides the elements necessary for management and others to make decisions and estimates how well a company may perform in the future. Accounting is the common "language" used by managers, investors, and others to communicate information about a business.
Bookkeeping is simply the procedural element of accounting that processes the accounting data. Accounting is an information system, of which bookkeeping is a component.(easy, L.O. 1)
118. What are the three forms of business organizations? How do they differ?
Solution: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 stockholders, who may or may not have a part in the day-to-day operations of the business. The stockholders 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).
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(moderate, L.O. 1)
119. List and define three generally accepted accounting concepts/principles discussed in Chapter 1.
Solution: Entity concept — An accounting entity is an organization or a section of an
organization that stands apart from other organizations and individuals as a separate, identifiable economic unit. From an accounting perspective, sharp boundaries are drawn around each entity so as not to confuse its affairs with those of other entities, such as the owner of a business and the business itself. This allows an objective measurement of accounting data to be taken and turned into useful information.
Reliability principle — Accounts records and statements are based on the most reliable data available so that they will be as accurate and as useful as possible. This principle is also called the objectivity principle.
Cost principle — This principle states that acquired assets and services should be recorded at their actual cost. The cost of an asset should be maintained in the accounting records for as long as the business holds the asset.
Going-concern principle — This principle holds that the entity will remain in operation for the foreseeable future. This principle allows certain assumptions to be made by management, investors, and other interested parties about the business and its operations into future accounting periods.
Stable-monetary-unit concept — This concept assumes that the dollar’s purchasing power is relatively stable and thus ignores the effect of inflation in the accounting records.
(moderate, L.O. 2)
120. Your friend has asked you to review and analyze the financial status of her company before she goes to the bank to request a loan. Answer the following questions:a. What will you need to review to make a sound decision?b. What will the bank be looking for? Be specific.
Solution:a. A decision maker would like to have access to all the financial statements of a
company for several years, including the income statement, balance sheet, statement of retained earnings, and statement of cash flows.
b. The bank will be looking at the company’s ability to repay the loan. The bank will look at the amount of income generated by the company for the past several years as well as whether or not it has been increasing or decreasing. The amount of debt already owed by the company will also be an issue. The bank would like to see that stockholders’ equity exceeds total liabilities at the time of the loan request. Also, dividends paid to the owner should not exceed the net income in any given period. These are indications that the owner is as much at risk as the bank would be if the loan were granted.
(difficult, L.O. 4)
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121. Listed below are several account titles. List the type of account listed by the account title. The first item is listed as an example.
Account Title Account Type
Equipment Asset
Notes Payable
Merchandise Inventory
Prepaid Insurance
Common Stock
Land
Accounts Receivable
Accounts Payable
Retained Earnings
Solution:
Account Title Account Type
Equipment Asset
Notes Payable Liability
Merchandise Inventory Asset
Prepaid Insurance Asset
Common Stock Equity
Land Asset
Accounts Receivable Asset
Accounts Payable Liability
Retained Earnings Equity
(easy, L.O. 3)
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122. Following is an alphabetical list of the assets, liabilities, revenues, and expenses of Great Smoky Bar-B-Que, Inc. Prepare an income statement for the year ended November 30, 2005.
Teutonic EnterprisesStatement of Retained Earnings
For the Year Ended June 30, 2006
Retained earnings, June 1, 2006 $15,000Add: Net income 12,500
$27,500Deduct: Dividends 10,200Retained earnings, June 30, 2006 $17,300
(moderate, L.O. 4)
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125. Bruce’s Auto Transport Service gathered together the following information regarding the asset, liability, stockholders’ equity, revenue, and expense accounts as of the end of its first year of operations, April 30, 2006:
Prepare a statement of retained earnings for Bruce’s Auto Transport Service for the year ended April 30, 2006.
Solution:Bruce’s Transport Service
Statement of Retained EarningsFor the Year Ended April 30, 2006
Retained earnings, May 1, 2005 $ 0Add: Net income 13,400
13,400Deduct: Dividends 8,300Retained earnings, April 30, 2006 $ 5,100
(moderate, L.O. 4)
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126. The following information was extracted from the accounting records of Hamilton Corporation as of December 31, 2007. Prepare a balance sheet for Hamilton Corporation.
Common stock 50,600Retained earnings 17,100Total stockholders’ equity 67,700Total liabilities and
Total assets $112,200 stockholders’ equity $112,200
(moderate, L.O. 4)
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127. Following is an alphabetical list of the assets, liabilities, and stockholders’ equity accounts of Waterloo-Ag Products, Inc. Prepare a balance sheet dated April 30, 2006.
128. Dreame House Realtors, Inc., prepared the following random list of assets, liabilities, revenues, and expenses from its December 31, 2006, accounting records. The beginning retained earnings as of January 1, 2006, was $43,100 and the owner, John Dreame, received dividends of $12,600 during the year. Prepare the balance sheet for Dreame House Realtors, Inc., as of December 31, 2006.
129. Renee Parker started a new florist business, Parker’s Poseys, on July 2, 2007, by investing $100,000 cash and receiving common stock in return. On July 31, Parker’s bookkeeper examined the following facts:
Parker had $18,000 in a personal checking account; the Parker’s Poseys account had a balance of $30,000.
Parker’s Poseys had $45,000 of inventory. Parker still owes $15,000 on account for this inventory.
Parker owed $5,000 on a personal credit card. Parker purchased a delivery van for the business for $38,000, paying $20,000 in
cash and signing a note payable for the remainder. Parker purchased furniture for the business for $15,000 cash. Parker purchased with cash $5,000 of office supplies to be used in the business. Parker owes $165,000 for a mortgage on a personal residence purchased for
$225,000.
Prepare the balance sheet of Parker’s Poseys as of July 31, 2007.
Total assets $133,000 stockholders’ equity $133,000(difficult, L.O. 4)
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130. Identify the financial statement where a decision maker can find the following items.
a. Dividendsb. Equipmentc. Insurance expensed. Cash paid for suppliese. Accounts receivablef. Beginning retained earningsg. Sales revenueh. Common stocki. Accounts payable
Solution:a. statement of retained earningsb. balance sheetc. income statementd. statement of cash flowse. balance sheetf. statement of retained earningsg. income statementh. balance sheeti. balance sheet
(moderate, L.O. 5)
131. Classify each statement below as an operating activity, investing activity, or a financing activity.
a. Sold 10,000 shares of stock for cash.b. Paid salaries of employees.c. Paid amount due for income taxes.d. Paid interest expense.e. Purchased office equipment for cash.f. Sold old office equipment and received cash.g. Received interest income.h. Paid interest on a bank loan.i. Paid dividends to stockholders.
132. The following information was extracted from the accounting records of Home Makers, Inc., for the year ended December 31, 2006 (in thousands).
Purchases of equipment $ 390 Issue common stock $ 76Net income 44 Payment of dividends 39Revenues 553 Sales of equipment 142Long-term borrowings 50 Accounts receivable 78Adjustments to reconcile Beginning cash 167 net income to cash 919
Prepare a statement of cash flows for the year ended December 31, 2006.
Solution:
Home Makers, Inc. Statement of Cash Flows
For the Year Ended December 31, 2006
Cash flows from operating activities:Net income $ 44Adjustments to reconcile net income to cash 919 Net cash provided by operating activities $963
Cash flows from investing activities:Sale of equipment $ 142 Purchase of equipment (390)
Net cash used for investing activities (248)Cash flows from financing activities:
Issue common stock $ 76Borrowings 50Payment of dividends (39)
Net cash used for financing activities $ 87 Net increase in cash $802Cash balance, January 1, 2006 167Cash balance, December 31, 2006 $969
(difficult, L.O. 5)
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133. Choose the appropriate definition for the terms below.
a. a business owned by a single ownerb. a statement summarizing the revenues and expenses for a given periodc. resources which provide future economic benefits to a businessd. claims by outsiders on the resources of a businesse. revenues less expensesf. a business owned by stockholdersg. shows the net change in the cash account for a given periodh. a formal listing of the accounting equation on a specified date
1. corporation 2. statement of cash flows 3. income statement 4. net income 5. proprietorship 6. balance sheet 7. liabilities 8. assets
Solution:1. f2. g3. b4. e5. a6. h7. d8. c
(moderate, L.O. all)
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QUESTIONS ON DECISION GUIDELINES
134. Think about the impact accounting has on our economy and our nation. Name some external groups interested in reviewing a company’s financial statements.
Solution: stockholders and other investors bankers other creditors Internal Revenue Service other governmental agencies the general public
(easy, L.O. 5)
135. What do stockholders look for when reviewing and analyzing the income statement?
Solution:When reviewing the income statement, stockholders look for steadily increasing levels of net income over time. Net income on an income statement means the company is profitable. A steady increase in net income indicates the company’s profits are solid. Net income affects both stock prices and future dividends. A stockholder’s personal wealth will be enhanced through an increase in the market price of the company’s stock and future dividends to be received.(moderate, L.O. 5)
136. What do stockholders look for when reviewing and analyzing the statement of cash flows?
Solution:When reviewing the statement of cash flows, stockholders look for indications that management is using cash wisely. Stockholders also like to see that the main source of cash is from operating activities, rather than from investing or financing activities. Cash from operating activities indicates that business operations are providing the company with sufficient cash flow.(difficult, L.O. 5)
137. What do creditors such as bankers look for when reviewing assets and liabilities on the balance sheet?
Solution:Assets show what the company can pledge as collateral that a creditor can collect if the company fails to pay its debts. Liabilities indicate how much the company owes other creditors. Assets should increase faster than liabilities over time. The amount of assets should exceed the amount of liabilities.(moderate, L.O. 5)
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138. What is the purpose of a statement of cash flows?
Solution:A statement of cash flows reports how the company generates and uses its cash. Wise use of cash usually generates revenues and additional cash. Operating activities should be the main source of cash. The statement of cash flows provides information that would be difficult to obtain from analyzing the other financial statements.(moderate, L.O. 5)
