CHAPTER 1
THE FINANCIAL STATEMENTS
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Use accounting vocabulary for decision making
Apply accounting concepts and principles
Use the accounting equation to describe an organization
Evaluate a company’s operating performance, financial position, and cash flows
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 notfor-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)
1-1
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)
1-2
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 managerial
b. internal and external
c. bookkeeping and decision-oriented
d. profit and nonprofit
(medium, L.O. 1, a)
28.
According to the author, potential investors need information that is:
a. fair and future-oriented
b. accurate and truthful
c. relevant and reliable
d. audited and complete
(medium, L.O. 1, c)
29.
Who ultimately controls a corporation?
a. the chief executive officer
b. board of directors
c. president
d. the stockholders
(medium, L.O. 1, d)
1-3
30.
Financial statements are:
a. reports issued by outside consultants who are hired to analyze key operations of the
business
b. reports created by management that states it is responsible for the acts of the
corporation
c. standard documents that tell us how well a business is performing and where it stands
in financial terms
d. 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. proprietorship
b. partnership
c. corporation
d. all of the above
(easy, L.O. 1, c)
32.
All of the following are forms of business organizations except:
a. proprietorship
b. partnership
c. restaurant
d. 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 Accountants
b. Securities and Exchange Commission
c. Financial Accounting Standards Board
d. 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 Accountants
b. the Securities and Exchange Commission
c. generally accepted accounting principles
d. the code of professional conduct for accountants
(moderate, L.O. 2, c)
35.
The acronym GAAP stands for:
a. government audited accounting pronouncements
b. generally accepted accounting principles
c. government authorized accountant principles
d. generally acceptable authorized pronouncements
(moderate, L.O. 2, b)
1-4
36.
All of the following are characteristics of useful accounting information except:
a. relevant
b. informative
c. consistent
d. 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 individuals
b. ensures that accounting records and statements are based on the most reliable data
available
c. holds that the entity will remain in operation for the foreseeable future
d. 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 individuals
b. ensures that accounting records and statements are based on the most reliable data
available
c. holds that the entity will remain in operation for the foreseeable future
d. 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 individuals
b. ensures that accounting records and statements are based on the most reliable data
available
c. holds that the entity will remain in operation for the foreseeable future
d. 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 principle
b. stable dollar principle
c. cost principle
d. reliability principle
(easy, L.O. 2, c)
41.
The reliability principle is also called the:
a. full and fair principle
b. truthfulness concept
c. relevance concept
d. objectivity principle
(moderate, L.O. 2, d)
1-5
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 cost
b. recorded value
c. book value
d. 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 only
b. the Tucson residence only
c. both the Phoenix and Tucson residences
d. 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, $25,000
b. fair market cost, $30,000
c. current market cost, $32,000
d. $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’ equity
b. Assets = Liabilities + Stockholders’ equity
c. Assets = Liabilities - Stockholders’ equity
d. 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)
1-6
48.
The owners’ interest in the assets of a corporation is known as:
a. long-term assets
b. stockholders’ equity
c. operating expenses
d. common stock
(moderate, L.O. 3, b)
49.
Claims held by the stockholders of a corporation are alternately known as:
a. retained earnings
b. paid-in capital
c. earned income
d. paid-in capital plus retained earnings
(difficult, L.O. 3, d)
50.
Payables are classified as:
a. increases in earnings
b. assets
c. decreases in earnings
d. liabilities
(easy, L.O. 3, d)
51.
Receivables are classified as:
a. increases in earnings
b. assets
c. decreases in earnings
d. liabilities
(easy, L.O. 3, b)
52.
The sum of "outsider claims" plus "insider claims" equals:
a. total assets
b. net income
c. total stockholders’ equity
d. total liabilities
(difficult, L.O. 3, a)
53.
Revenues are:
a. increases in liabilities resulting from delivering goods or services to customers
b. increases in retained earnings resulting from delivering goods or services to customers
c. decreases in assets resulting from delivering goods or services to customers
d. 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.
d. None of these answers are correct.
(moderate, L.O. 3, c)
1-7
55.
Expenses are:
a. increases in assets resulting from operations
b. increases in retained earnings resulting from operations
c. increases in liabilities resulting from purchasing assets
d. decreases in retained earnings resulting from operations
(moderate, L.O. 3, d)
56.
Dividends:
a. always affect net income
b. are distributions to stockholders of assets (usually cash) generated by net income
c. are expenses
d. 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 of
a. assets and liabilities
b. revenues and expenses
c. net income and dividends
d. common stock and retained earning
(moderate, L.O. 3, d)
58.
Net income is computed as:
a. revenues – expenses
b. revenues + expenses
c. revenues – expenses + dividends
d. 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. revenues
b. expenses
c. dividends
d. 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. $ 80,000
b. $130,000
c. $140,000
d. $190,000
(moderate, L.O. 3, b)
1-8
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 $15,000
b. increase of $15,000
c. increase of $30,000
d. 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?
Net
Income
a.
$50,000
b.
$80,000
c.
$80,000
d.
$250,000
(moderate, L.O. 3, b)
Change in
Retained
Earnings
$50,000
$50,000
$80,000
$250,000
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. $230,000
b. $250,000
c. $280,000
d. $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 $95,000
b. decrease $145,000
c. decrease $95,000
d. 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 $145,000
b. increase $145,000
c. increase $95,000
d. decrease $95,000
(difficult, L.O. 3, c)
1-9
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. $40,000
b. $15,000
c. $30,000
d. The amount is indeterminable from the given information.
(difficult, L.O. 3, c)
67.
Dividends appear on the:
a. retained earnings statement
b. income statement
c. balance sheet
d. both the retained earnings statement and the income statement
(moderate, L.O. 4, a)
68.
Assets appear on the:
a. balance sheet
b. income statement
c. retained earnings statement
d. statement of cash flows
(easy, L.O. 4, a)
69.
Common stock appears on the:
a. balance sheet
b. income statement
c. statement of cash flows
d. retained earnings statement
(easy, L.O. 4, a)
70.
A company’s gross profit for the period is reported on the:
a. balance sheet
b. statement of cash flows
c. income statement
d. 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 sheet
b. the income statement
c. the retained earnings statement
d. the statement of cash flows
(easy, L.O. 4, b)
1-10
72.
The ending balance in Retained Earnings appears on the:
a. balance sheet only
b. balance sheet and statement of retained earnings
c. statement of retained earnings only
d. income statement
(moderate, L.O. 4, b)
73.
Cash dividends:
a. decrease revenue on the income statement
b. increase expenses on the income statement
c. decrease retained earnings on the retained earnings statement
d. 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 sheet
b. statement of operations
c. statement of retained earnings
d. 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 examine
a. the statement of cash flows
b. the income statement
c. the balance sheet
d. 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 sheet
b. income statement
c. statement of cash flows
d. retained earnings statement
(moderate, L.O. 4, b)
77.
Which statement summarizes the revenues and expenses of an entity?
a. balance sheet
b. statement of cash flows
c. statement of retained earnings
d. statement of operations
(moderate, L.O. 4, d)
1-11
78.
Which financial statement provides a "snapshot photo" of one moment in time?
a. balance sheet
b. income statement
c. statement of retained earnings
d. statement of cash flows
(moderate, L.O. 4, a)
79.
The income statement:
a. reports the results of operations since the inception of the business
b. covers a defined period of time
c. is not dated
d. 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 period
b. assets and liabilities of an entity
c. cash inflows and outflows of an entity
d. 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 profit
b. directly after cost of goods sold
c. directly after revenue
d. 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 profit
b. appears on the balance sheet as a deduction from sales
c. appears on the income statement as a deduction from sales
d. 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. $25
b. $35
c. $60
d. None of these answers are correct.
(easy, L.O. 4, a)
1-12
84.
Net income is:
a. deducted from beginning retained earnings on the retained earnings statement
b. added to beginning retained earnings on the retained earnings statement
c. added to assets on the balance sheet
d. deducted from net sales on the income statement
(moderate, L.O. 4, b)
85.
A net loss occurs when:
a. total revenues exceed total expenses
b. total expenses exceed total revenues
c. total revenues and dividends exceed total expenses
d. total revenues exceed total expenses and dividends
(moderate, L.O. 4, b)
86.
The balance sheet is alternately known as the:
a. operating statement
b. assets statement
c. statement of financial position
d. statement of profit and loss
(moderate, L.O. 4, c)
87.
The balance sheet reports information about:
a. liabilities, equity, and expenses
b. assets, revenues, and liabilities
c. assets, liabilities, and equity
d. revenues, expenses, and equity
(easy, L.O. 4, c)
88.
Assets are generally classified as:
a. current assets and producing assets
b. producing assets and consumable assets
c. long-term assets and consumable assets
d. 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 year
b. within the next 12 months or within the business’s normal operating cycle if longer
than a year
c. within the next 6 months
d. within the next 24 months
(moderate, L.O. 4, b)
1-13
90.
Notes receivable due in 60 days would be classified as a:
a. long-term asset on the balance sheet
b. current asset on the balance sheet
c. current liability on the balance sheet
d. long-term liability on the balance sheet
(easy, L.O. 4, b)
91.
Equipment would appear on the:
a. income statement with the revenues
b. balance sheet with the long-term assets
c. balance sheet with the current assets
d. income statement with the operating expenses
(easy, L.O. 4, b)
92.
Depreciation is normally associated with which asset on the balance sheet?
a. land
b. accounts receivable
c. inventory
d. equipment
(moderate, L.O. 4, d)
93.
Accounts receivable would appear on the:
a. income statement with the revenues
b. retained earnings statement with the net income
c. balance sheet with the current assets
d. 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 expenses
b. retained earnings statement with the dividends
c. balance sheet with the current assets
d. 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 sheet
b. current liability on the balance sheet
c. expense on the income statement
d. 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 activities
b. accrual activities
c. financing activities
d. operating activities
(moderate, L.O. 4, a)
1-14
97.
Stockholders’ equity increases as a result of:
a. owner investments
b. a net loss during the period
c. a net income during the period
d. 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’ equity
b. decreases the amount of owners’ equity
c. decreases the amount of total liabilities
d. 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 activities
b. operating, investing, and financing activities
c. increasing, decreasing, and noncash activities
d. 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 activities
b. operating activities, investing activities, and financing activities
c. operating activities, financing activities, and investing activities
d. 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 flows
b. as a noncash financing activity on a statement of cash flows
c. as an investing activity on the statement of cash flows
d. 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 flows
b. financing activity on a statement of cash flows
c. operating activity on a statement of cash flows
d. 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 flows
b. financing activity on a statement of cash flows
c. operating activity on a statement of cash flows
d. current asset on the balance sheet
(difficult, L.O. 4, b)
1-15
104.
Cash collected from customers would appear on the statement of cash flows as a(n):
a. operating activity
b. financing activity
c. investing activity
d. 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 activities
b. on the statement of financial position with the current liabilities
c. on the statement of earnings with the revenues
d. 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 operations
c. the change in assets and liabilities due to the results of operations
d. 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 flows
c. statement of financial position
d. 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 sheet
b. statement of assets
c. statement of financial position
d. statement of retained earnings
(moderate, L.O. 5, d)
109.
The balance sheet contains:
a. the amount of net income
b. the beginning balance in retained earnings
c. the ending balance in retained earnings
d. the amount of dividends paid to stockholders
(moderate, L.O. 5, c)
110.
What is one component of stockholders’ equity?
a. common stock
b. notes payable
c. property, plant, and equipment
d. cash
(easy, L.O. 5, a)
1-16
111.
Which financial statement must be prepared before the others?
a. income statement
b. balance sheet
c. statement of cash flows
d. retained earnings statement
(moderate, L.O. 5, a)
112.
The SEC Edgar file contains information on:
a. all profitable US companies
b. all companies on the SEC "watch list"
c. recommended US and international companies
d. 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 assets
b. operating activities
c. financing activities
d. 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 sheet
b. statement of retained earnings and balance sheet, but not the income statement or
statement of cash flows
c. statement of retained earnings, statement of cash flows, and balance sheet, but not the
income statement
d. 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 the
a. current and projected inventory levels
b. sales revenue trend
c. net income for the current period and projected net income for the next period
d. operating activities section of the cash flow statement
(moderate, L.O. 5, b)
1-17
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).
(moderate, L.O. 1)
1-18
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)
1-19
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)
1-20
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.
Accounts payable
Accounts receivable
Advertising expense
Cash
Cost of goods sold
Inventory
Interest expense
$ 2,800
5,400
2,600
9,100
29,800
7,900
800
Note payable
Rent expense
Salary expense
Salary payable
Sales revenue
Supplies expense
Utilities expense
Solution:
Great Smoky Bar-B-Que, Inc.
Income Statement
For the Year Ended November 30, 2005
Revenues:
Sales revenue
Expenses:
Cost of goods sold
Rent expense
Salary expense
Advertising expense
Supplies expense
Interest expense
Utilities expense
Net income
$78,800
$29,800
10,200
12,100
2,600
1,800
800
700
(moderate, L.O. 4)
1-21
58,000
$20,800
$ 4,000
10,200
12,100
900
78,800
1,800
700
123.
Northwestern Express Enterprises gathered together the following information at the end
of its first year of operations, September 30, 2006:
Rent expense
Truck
Supplies
Salary expense
Accounts receivable
Note payable
Common stock
$ 7,500
14,600
2,500
19,400
8,200
11,000
25,000
Dividends
Accounts payable
Service revenue
Salary payable
Utilities expense
Interest expense
Cash
$10,200
6,700
45,500
1,200
5,000
1,500
20,800
Prepare an income statement for Northwestern Express Enterprises for the year ended
September 30, 2006.
Solution:
Northwestern Express Enterprises
Income Statement
For the Year Ended September 30, 2006
Revenues:
Service revenue
Expenses:
Salary expense
Rent expense
Utilities expense
Interest expense
Net income
$45,500
$19,400
7,500
5,000
1,500
33,400
$12,100
(moderate, L.O. 4)
1-22
124.
The following accounts were extracted from the accounting records of Teutonic
Enterprises following its second year of operations, June 30, 2006:
Rent expense
Truck
Supplies
Salary expense
Accounts receivable
Note payable
Common stock
$ 7,500
13,600
2,500
19,400
8,200
10,000
25,000
Dividends
Accounts payable
Service revenue
Salary payable
Utilities expense
Interest expense
Cash
$10,200
6,700
45,600
2,200
5,000
1,200
21,900
Retained earnings at the end of the first year of operations was $15,000.
Prepare an income statement and a statement of retained earnings for Teutonic
Enterprises.
Solution:
Teutonic Enterprises
Income Statement
For the Year Ended June 30, 2006
Revenues:
Sales revenue
Expenses:
Salary expense
Rent expense
Utilities expense
Interest expense
Net income
$45,600
$19,400
7,500
5,000
1,200
33,100
$12,500
Teutonic Enterprises
Statement of Retained Earnings
For the Year Ended June 30, 2006
Retained earnings, June 1, 2006
Add: Net income
$15,000
12,500
$27,500
10,200
$17,300
Deduct: Dividends
Retained earnings, June 30, 2006
(moderate, L.O. 4)
1-23
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:
Accounts payable
Accounts receivable
Cash
Common stock
Dividends
Interest expense
Note payable
$ 6,700
8,200
23,800
25,000
8,300
1,200
11,000
Rent expense
Salary expense
Salary payable
Service revenue
Supplies
Truck
Utilities expense
$ 6,500
19,400
1,200
45,500
2,500
14,600
5,000
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 Earnings
For the Year Ended April 30, 2006
Retained earnings, May 1, 2005
Add: Net income
Deduct: Dividends
Retained earnings, April 30, 2006
$
0
13,400
13,400
8,300
$ 5,100
(moderate, L.O. 4)
1-24
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.
Accounts payable
Accounts receivable
Cash
Common stock
Equipment
$11,200
40,000
21,600
50,600
24,600
Inventory
Note payable
Retained earnings
Salary payable
Supplies
$23,500
31,000
17,100
2,300
2,500
Solution:
Hamilton Corporation
Balance Sheet
December 31, 2007
Assets
Cash
Accounts receivable
Inventory
Supplies
Equipment
Total assets
$21,600
40,000
23,500
2,500
24,600
$112,200
Liabilities
Accounts payable
$11,200
Note payable
31,000
Salary payable
2,300
Total liabilities
44,500
Stockholders’ equity
Common stock
50,600
Retained earnings
17,100
Total stockholders’ equity
67,700
Total liabilities and
stockholders’ equity
$112,200
(moderate, L.O. 4)
1-25
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.
Accounts payable
Accounts receivable
Cash
Common stock
Inventory
$10,200
17,000
30,900
32,400
34,000
Note payable
Retained earnings
Salary payable
Supplies
$15,000
27,500
10,700
13,900
Solution:
Waterloo-Ag Products, Inc.
Balance Sheet
April 30, 2006
Assets
Cash
Accounts receivable
Inventory
Supplies
Total assets
$30,900
17,000
34,000
13,900
Liabilities
Accounts payable
Note payable
Salary payable
Total liabilities
$95,800
Stockholders’ equity
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and
stockholders’ equity
(moderate, L.O. 4)
1-26
$10,200
15,000
10,700
35,900
32,400
27,500
59,900
$95,800
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.
Accounts receivable
Interest expense
Supplies
Accounts payable
Utilities expense
Furniture
Salary payable
Common stock
$15,700
4,900
1,500
6,100
5,200
18,000
2,400
30,500
Service revenue
Cash
Note payable
Salary expense
Interest payable
Rent expense
Automobiles
Land
$50,500
28,000
17,000
18,000
1,600
9,400
14,900
23,000
Solution:
Dreame House Realtors, Inc.
Balance Sheet
December 31, 2006
Assets
Cash
Accounts receivable
Supplies
Furniture
Automobiles
Land
Total assets
$ 28,000
15,700
1,500
18,000
14,900
23,000
$101,100
Liabilities
Accounts payable
Note payable
Interest payable
Salary payable
Total liabilities
$ 6,100
17,000
1,600
2,400
27,100
Stockholders’ equity
Common stock
30,500
Retained earnings
43,500 *
Total stockholders’ equity
74,000
Total liabilities and
stockholders’ equity
$101,100
* $43,500 = $43,100 + $13,000 (net income) - $12,600
Net income = $50,500 - $4,900 - $5,200 - $18,000 - $9,400
(difficult, L.O. 4)
1-27
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.
Solution:
Parker’s Poseys, Inc.
Balance Sheet
July 31, 2007
Assets
Cash
Supplies
Inventory
Furniture
Delivery van
$ 30,000
5,000
45,000
15,000
38,000
Total assets
(difficult, L.O. 4)
$133,000
Liabilities
Accounts payable
Note payable
Total liabilities
$ 15,000
18,000
$ 33,000
Stockholders’ equity
Common stock
$100,000
Total liabilities and
stockholders’ equity
$133,000
1-28
130.
Identify the financial statement where a decision maker can find the following items.
a.
b.
c.
d.
e.
f.
g.
h.
i.
Dividends
Equipment
Insurance expense
Cash paid for supplies
Accounts receivable
Beginning retained earnings
Sales revenue
Common stock
Accounts payable
a.
b.
c.
d.
e.
f.
g.
h.
i.
statement of retained earnings
balance sheet
income statement
statement of cash flows
balance sheet
statement of retained earnings
income statement
balance sheet
balance sheet
Solution:
(moderate, L.O. 5)
131.
Classify each statement below as an operating activity, investing activity, or a financing
activity.
a.
b.
c.
d.
e.
f.
g.
h.
i.
Sold 10,000 shares of stock for cash.
Paid salaries of employees.
Paid amount due for income taxes.
Paid interest expense.
Purchased office equipment for cash.
Sold old office equipment and received cash.
Received interest income.
Paid interest on a bank loan.
Paid dividends to stockholders.
a.
b.
c.
d.
e.
f.
g.
h.
i.
financing activity
operating activity
operating activity
operating activity
investing activity
investing activity
operating activity
operating activity
financing activity
Solution:
(moderate, L.O. 4)
1-29
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
Net income
44
Revenues
553
Long-term borrowings
50
Adjustments to reconcile
net income to cash
919
Issue common stock
Payment of dividends
Sales of equipment
Accounts receivable
Beginning cash
$ 76
39
142
78
167
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
Adjustments to reconcile net income to cash
Net cash provided by operating activities
Cash flows from investing activities:
Sale of equipment
Purchase of equipment
Net cash used for investing activities
Cash flows from financing activities:
Issue common stock
Borrowings
Payment of dividends
Net cash used for financing activities
Net increase in cash
Cash balance, January 1, 2006
Cash balance, December 31, 2006
(difficult, L.O. 5)
1-30
$ 44
919
$963
$ 142
(390)
(248)
$ 76
50
(39)
$ 87
$802
167
$969
133.
Choose the appropriate definition for the terms below.
a.
b.
c.
d.
e.
f.
g.
h.
a business owned by a single owner
a statement summarizing the revenues and expenses for a given period
resources which provide future economic benefits to a business
claims by outsiders on the resources of a business
revenues less expenses
a business owned by stockholders
shows the net change in the cash account for a given period
a formal listing of the accounting equation on a specified date
1.
2.
3.
4.
5.
6.
7.
8.
corporation
statement of cash flows
income statement
net income
proprietorship
balance sheet
liabilities
assets
Solution:
1.
2.
3.
4.
5.
6.
7.
8.
f
g
b
e
a
h
d
c
(moderate, L.O. all)
1-31
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)
1-32
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)
1-33