Accounting Chapter 1 Answers: Intro to Financial Statements

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A. Balance sheet
which of the following financial statements reports information as of a specific date?
A. Balance sheet
B. Income statement
C. Retained earning statement
D. Statement of cash flows
Balance sheet is prepared as of a specific date while Income statements, retained earnings statement, and a statement of cash flows are all for a period of time such as a month.
Sole Proprietorship
Single owner
– Simple to establish
– Owner controlled
– Tax advantages
Business owned by 2 or more individuals; organization form used by accounting firms and law firms.
– Simple to establish
– Shared control
– Broader skills and resources
– Tax advantages
A business organized as a seperate legal entity owned by stockholders. Ownership evidenced by shares of stock
– Easier to transfer ownership
-Easier to raise funds
– No personal liability
– Can attract large amounts of capital investment
– Allows for easy transfer of ownership (through stocks)
– Can attract professional management
– Provides stockholders with limited liability
– Subject to more gov. regulations
– Difficulty knowing whether management is making decisions in shareholders’ best interests
– Subject to income tax
Share of stock
Certificate that acts as evidence of ownership in a corporation
Limited liability
Owner of corporation is shielded from liability of corporation. Partnerships and sole proprietorships are directly liable
1. Corporation
2. Sole proprietorship and partnership
3. Corporation
4. Sole proprietorship and partnership
5. Corporations
Corporation, sole proprietorship, or partnership?
1. Easier to raise funds
2. Simple to establish
3. No personal legal liability
4. Tax advantages
5. Easier to transfer ownership
The information system that identifies, records, and communicates the economic events of an organization to interested users
Purpose of accounting
Provide economic information as inputs for decision making by users of the information
Internal users
Work inside of a business. Businesses’ employees such as management. Include marketing managers, production supervisors, finance directors and company officers
Internal users
Managers who need accounting information to plan, organize, and run business operations.
External users
People who are not employees of the business but use the businesses’ financial info to make informed judgments.
Owners (investors) and creditors
External users
Investors and creditors. Investors (stockholders) use accounting information to help them decide whether to buy, hold or sell shares of a company’s stock. Creditor’s use accounting information to assess the risk of granting credit or loaning money to a business
Ethics in financial reporting
US regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting.
Sarbanes Oxeley Act
An act of congress in 2002 intended to bring reform to corporate accountability and stewardship in the wake of a number of major corporate scandals. Resulted in:
1. Top management must now certify the accuracy of financial info
2. Penalties for fraudulent activity was increased
3. Independence of auditors was increased
4. Increased oversight by the board of directors must occur, including the board’s selection and supervision of the independent auditor
Solving ethical dilemma
1. Recognize an ethical situation and the ethical issues involved
2. Identify and analyze the principal elements in the situation
3. Identify the alternatives, and weigh the impact of each alternative on various stakeholders
What are the 3 activities all business are involved in?
Accounting information system
Keeps track of the results of each of the 3 business activities
Financing activities
Involve collecting the necessary funds to support the business. Transactions with creditors and owners.
– Borrowing money is debt financing. Amounts owed are liabilities. Party to whom amounts are owed are creditors
– Issuing (selling) shares of stock for cash. Payments to stockholders are called dividends
All of the following are examples of which business activity?
– Taking out a loan at a bank
– Borrowing directly from investors
– Selling shares of stock to investors
Payments from a business to stockholders/shareholders.
A certificate that represents a corporation’s promise to repay a certain amount of money and interest in the future
Nonbusiness entity
Organization operated for some purpose other than to earn a profit; government entities/private orgs
Capital stock
Indicates the owners contributions to a corporation
One of the owners of a corporation… AKA a shareholder
Someone to whom a company or person has a debt AKA a lender
Investing activities
Involves the purchasing of resources a company needs in order to operate. Computers, delivery trucks, furniture, building, etc. Also includes investing
Resources owned by a business. Things such as computers, cash, delivery trucks, furniture, buildings etc. are all know as PPE (property, plant and equipment)
Operating activities
Involve putting the resources of the business into action to generate a profit. Once a business has the assets it needs, it can begin its operations by selling product. Items commonly affects by operation include:
– Revenues
– Inventory
– Receivables
Amounts earned from the sale of products
Goods available for sale to customers
Right to receive money from another party (Accounts receivable are owed by customers; interest receivable is owed by debtors)
Costs of assets consumed or services used in the process of generating revenues. Opposite of revenues (Cost of goods sold, selling, marketing, income taxes expense)
Represent amounts owed to another party (creditors) in the form of debts or other obligations (accounts payable, interest payable, wages payable, sales taxes payable, income taxes payable)
Net income
The excess revenues over expenses. Example:
$1000 in revenue, $600 in expenses, $100 to employees = $300 net income
Retained earnings
The amount of net income retained in the corporation
Net loss
The excess of expenses over revenues
1. Expense
2. Asset
3. Liability
4. Common stock
5. Revenue
6. Liability
Classify each item as an asset, liability, common stock, revenue, or expense
1. Cost of renting property
2. Truck purchased
3. Notes payable
4. Issuance of ownership shares
5. Amount earned from providing service
6. Amounts owed to suppliers
Communicating with users
Business prepare 4 financial statements from the summarized accounting data:
1. Income statement
2. Retained earnings statement
3. Balance sheet
4. Statement of cash flows
*Often, a company perpares a Statement of Stockholders’ Equity rather than a Retained Earnings statement*
Retained earnings statement
Beginning equity + Owner contributions + Net income – dividends = ending equity (retained earnings)
Statement of Cash Flows
Cash inflows – Cash outflows = net cash flow
Includes investments from owners. Goes up if an additional owner comes in or additional investments from owners.
Income statement
Reports revenues and expenses for a specific period of time. Past net income provides information for predicting future net income.
Net income = revenues – expenses
Balance sheet
Reports assets, liabilities and equities as a particular point in time. *Assets = liabilities + Stockholders’ equity (A=L+E)*
Net income will result during a time period when:
A. assets exceed liabilities
B. assets exceed revenues
C. expenses exceed revenues
D. revenues exceed expenses
Annual report
A report prepared by corporate management that presents financial information including financial statements, a management discussion and analysis section, notes, and an independent auditor’s report. US companies that are publicly traded must provide shareholders with an annual report.
These are more comprehensive than a financial statement,
Always includes:
1. Financial statements
2. Management discussion and analysis
3. Notes to financial statements
4. Auditors report
Management discussion and analysis (MD&A)
Covers the companies ability to pay near-term obligations, its ability to fund open operations and expansion, and its results of operations. Must highlights favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors
Other elements of annual report
– Clarify the financial statements.
– Provide additional qualitative and/or quantitative detail
An accountant, who conducts independent examinations of a companies financial statements in order to express an opinion regarding the fairness or accuracy of a companies financial statements and the companies conformance with the generally accepted accounting principals. (GAAP)
Auditors report
Expresses an opinion as to whether the financial statements present fairly the company’s results of operations and financial position
Generally accepted accounting principals. (GAAP)
Various methods, rules, practices, and other procedures that have evolved over time in response to the need to regulate the preparation of financial statements
Auditors opinion
As to the fairness of the presentation of the financial position and results of operations and their conformance with GAAP
Unqualified opinion
Indicates that the financial statements are materially correct and fairly presented, no significant errors
Qualified opinion
The auditor has a limitation of scope within the audit or there is a violation of GAAP
The auditor is unable to satisfy himself or herself that the financial statements are fairly stated will use the ___________ of opinion
Adverse opinion
The auditor believes the financial statements are so materially misstated or misleading that they do not represent the company or comply with GAAP.
1. Notes to financial statement
2. Auditors report
3. Notes to financial statement
4. MD&A
5. MD&A
6. Auditors report
State whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to financial statements, or the auditors report
1. Descriptions of significant account policies
2. Unqualified opinion
3. Explanations of uncertainties and contingencies
4. Description of ability to fund operations and expansion
5. Description of results of operation
6. Certified public accountant (CPA)
Notes to financial statements
“Information about interest rates that the company is being charged on outstanding debts and their due dates” would be included in what part of the annual report
C (Net income exceeded zero so its revenue must have exceeded its expenses)
Consider the following situation: The retained earnings statement of Grant Corporation shows dividends of $68,000, while net income for the year was $75,000. Which statement must be true?
A. None of these
B. All of these
C. Grant’s revenues must have exceeded its expenses
D. Grant’s revenues must have exceeded its dividends
E. Grant’s expenses must have exceeded its revenues
An individual who has met certain criteria and is thus allowed to perform audits of corporations
Retained earnings and common stock both fall under what?

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