Eastern Gateway Comuntiy College, YoungstownBUSSINESS 201Chapter 1 Answers

CHAPTER ONE Introduction to Financial Accounting Concept Self‐check 1. Managerial accounting serves the decision‐making needs of internal users. Financial accounting focuses on external reporting and meeting the nee ...

CHAPTER ONE Introduction to Financial Accounting Concept Self‐check 1. Managerial accounting serves the decision‐making needs of internal users. Financial accounting focuses on external reporting and meeting the needs of users like creditors and stockholders. 2. Business organizations sell products and services for profit. A non‐business organization exists to meet various societal needs and does not have profit as a goal. Examples of non‐business organizations are churches, mosques, and hospitals. 3. There are three common forms of business organizations—a proprietorship, a partnership, and a corporation. A proprietorship is a business owned by one person. A partnership is a business owned by two or more individuals. A corporation is a business owned by one or more stockholders. 4. Limited liability means that the stockholders of a corporation are not responsible for the corporation’s debts. The most that stockholders can lose is what they invested in the corporation. 5. Generally accepted accounting principles (GAAP) refer to the guidelines for financial accounting used in any given jurisdiction. They include the standards and common, agreed practices that accountants follow in recording and summarizing financial information, and in the preparation of financial statements.2 CHAPTER ONE / Introduction to Financial Accounting First US Edition Concept Self‐check continued 6. The six qualitative characteristics of GAAP are relevance, faithful representation, comparability, verifiability, timeliness, and understandability.  relevant information has the ability to make a difference in the decision‐making process;  faithful representation means that information is complete, neutral, and free from error;  comparability tells users of the information that businesses utilize similar accounting practices;  verifiability means that others are able to confirm that the information accurately represents the economic activities of the business;  timely information is available to decision makers while it is still useful; and  understandable information is clear and concise. 7. Financial statements evaluate the performance of an entity and measure its progress. Financial information is collected, then summarised and reported in the financial statements (balance sheet, income statement, statement of cash flows, and statement of changes in equity). 8. The purpose of the income statement is to communicate the inflow of assets, in the form of revenues, and the outflow or consumption of assets, in the form of expenses, over a period of time. Total inflows greater than total outflows creates net income or profit, which is reported on the income statement and in retained earnings in the stockholders’ equity section of the balance sheet. The purpose of the balance sheet is to communicate what the entity owns (its assets), what the entity owes (its liabilities), and the difference between assets and liabilities (its equity) at a point in time. 9. Revenue is an increase in an entity’s assets or a decrease in liabilities in return for services performed or goods sold, expressed in monetary units like dollars. An expense is an asset that is used up or obligations incurred in selling goods or performing services. 10. Net income is the difference between revenues and expenses. It is one measure of the success of the entity. 11. The statement of changes in equity shows why common stock and retained earnings have changed over a specified period of time – for instance, when shares are issued or net income is earned. 12. Stockholders’ equity consists of common stock and retained earnings. Common stock represents how much stockholders have invested. Retained earnings is the sum of all net incomes earned (net of losses incurred) by a corporation over its life, less any distributions of these net incomes to stockholders. 13. Dividends are distributions of retained earnings to stockholders.CHAPTER ONE / Introduction to Financial Accounting First US Edition 3 Concept Self‐check continued 14. The balance sheet consists of assets, liabilities, and stockholders’ equity. Liabilities plus stockholders’ equity always equal assets. 15. An asset is anything of value that is owned by the entity. Assets are economic resources controlled by an entity. They have some future value to the entity, usually for used generating revenue. 16. A liability is an obligation to pay an asset or to provide services or goods in the future. Until the obligations are paid, creditors have claims against the assets of the entity. Stockholders’ equity represents the amount of assets owing to the owners of the entity. The total assets of an entity belong either to the stockholders or to the creditors. 17. The statement of cash flows (SCF) explains how the cash reported on the balance sheet changed over a period of time by detailing its sources and uses of cash. The income statement does not disclose all important activities of the entity involving cash that is shown on the SCF, like investment in long‐lived assets or repayment of debt. 18. Notes to the financial statements provide greater detail about various amounts shown in the financial statements, or provide non‐quantitative information that is useful to users, like loan repayment terms. 19. The double entry accounting system is used to record financial transactions. Each transaction affects at least two items in the accounting equation, in order to maintain its equality. For example, a. Revenue is earned in cash: The asset Cash increases and Stockholders’ Equity increases by the same amount. (Net income increases. This increases Retained Earnings, which is part of Stockholders’ Equity.) b. An obligation is paid: The liability Accounts Payable decreases and the asset Cash decreases by the same amount. c. An amount owing from a customer is collected: The asset Cash increases and the asset Accounts Receivable decreases equally. In this way, the accounting equation always remains in balance after each transaction is recorded. 20. Financial statements are prepared at regular intervals to keep a number of interested groups informed about the financial performance of a corporation. The timing is determined in response to the needs of management in running the entity or of outside parties, such as bankers and stockholders. These external users make lending or investing decision in part based on the financial statements.4 CHAPTER ONE / Introduction to Financial Accounting First US Edition Concept Self‐check continued 21. The accounting equation takes the following form: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY (Economic resources owned by an entity) (Creditors’ claims to assets) (Owners’ claims to assets, or residual claims) The entity has assets, which are the resources it owns. The total assets owned by an entity must always equal the total claims of creditors and owners, who have the residual claims. 22. The exchange of assets or obligations by a business entity, expressed in monetary terms like dollars, is called a financial transaction. The exchange of cash for land or a building is an example of such a transaction. CP 1–1 A = L + +E (+) (+) Issued common stock for cash (+)(‐) Purchased a truck for cash (+) (+) Received a bank loan to pay for equipment (+)(‐) Purchased the equipment for cash (+)(‐) Made a deposit for electricity service to be provided in the future (‐) (‐) Paid rent for the month just ended No Effect Signed a new union contract that provides for increased wages in the future No Effect Hired a messenger service to deliver letters during a mail strike (‐) (‐) Received a parcel; paid the delivery service (+) (+) Billed customers for services performed (‐) (‐) Made a cash payment to satisfy an outstanding obligation (+)(‐) Received a payment of cash in satisfaction of an amount owed by a customer (+) (+) Collected cash from a customer for services rendered the same day (‐) (‐) Paid cash for truck expenses (gas, oil, etc.) (‐) (‐) (‐) Made a monthly payment on the bank loan; this payment included a payment on part of the loan and also an amount of interest expense. Stockholders’ equity is affected because interest expense is incurred (‐) (+) Issued shares in the company to pay off a loan (‐) (‐) Paid a dividend with cash.