Financial Statements and Business Decisions
ANSWERS TO QUESTIONS
1. Accounting is a system that collects and processes (analyzes, measures, and records) financial information about an organization and reports that information to decision makers.
2. Financial accounting involves preparation of the four basic financial statements and related disclosures for external decision makers. Managerial accounting involves the preparation of detailed plans, budgets, forecasts, and performance reports for internal decision makers.
3. Financial reports are used by both internal and external groups and individuals. The internal groups are comprised of the various managers of the ...view middle of the document...
The heading of each of the four required financial statements should include the following:
(a) Name of the entity
(b) Name of the statement
(c) Date of the statement, or the period of time
(d) Unit of measure
8. (a) The purpose of the income statement is to present information about the revenues, expenses, and the income of the entity for a specified period of time.
(b) The purpose of the balance sheet is to report the financial position of an entity at a given date, that is, to report information about the assets, obligations and stockholders’ equity of the entity as of a specific date.
(c) The purpose of the statement of cash flows is to present information about the flow of cash into the entity (sources), the flow of cash out of the entity (uses), and the net increase or decrease in cash during the period.
(d) The statement of retained earnings reports the way that net income and distribution of dividends affected the retained earnings of the company during the accounting period.
9. The income statement and the statement of cash flows are dated “For the Year Ended December 31, 2008,” because they report the inflows and outflows of resources during a period of time. In contrast, the balance sheet is dated “At December 31, 2008,” because it represents the resources, obligations and stockholders’ equity at a specific date.
10. Assets are important to creditors and investors because assets provide a basis for judging whether sufficient resources are available to operate the company. Assets are also important because they could be sold for cash in the event the company goes out of business. Liabilities are important to creditors and investors because the company must be able to generate sufficient cash from operations or further borrowing to meet the payments required by debt agreements. If a business does not pay its creditors, the law may give the creditors the right to force the sale of assets sufficient to meet their claims.
11. Net income is the excess of total revenues over total expenses. Net loss is the excess of total expenses over total revenues.
12. The accounting equation for the income statement is Revenues - Expenses = Net Income (or Net Loss if the amount is negative). Thus, the three major items reported on the income statement are (1) revenues, (2) expenses, and (3) income.
13. The accounting equation for the balance sheet is: Assets = Liabilities + Stockholders’ Equity. Assets are the probable (expected) future economic benefits owned by the entity as a result of past transactions. They are the resources owned by the business at a given point in time such as cash, receivables, inventory, machinery, buildings, land, and patents. Liabilities are probable (expected) debts or obligations of the entity as a result of past transactions which will be paid with assets or services in the future. They are the obligations of the entity such as accounts payable, notes...