Ch. 2: Constructing Financial Statements

Question 1

Characteristics required for an asset to be placed (capitalised) on the balance sheet

Answer 1

1. Must be owned or controlled by the company:
   - Legal title or unrestricted right to use the asset

Must possess expected future benefits that can be measured:

• Benefits can be expected as cash receipts or a reduction of liabilities
• A monetary value must be assignable to assets

Question 2

Current assets

Answer 2

Assets expected to be converted into cash or used in operations within the next year, or within the next operating cycle.

Listed in order of liquidity.

Types:

• Cash—currency, bank deposits, certificates of deposit and other cash equivalents.
• Marketable securities—short-term investments that can be quickly sold to raise cash
• Accounts receivable—amounts due to the company from customers arising from the sale of products or services on credit
• Inventory—goods purchased or produced for sale to customers
• Prepaid expenses—costs paid in advance for rent, insurance, or other services

Question 3

Non-current assets

Answer 3

Listed after current assets on the balance sheet.

Not expected to expire or be converted into cash within one year, or within the next operating cycle.

Referred to as long-term assets.

Types:

• Long-term financial investments—investments in debt securities or shares of other firms that management does not intend to sell in the near future
• Property, plant and equipment (PPE)—land, factory buildings, warehouses, office buildings, machinery, office equipment, and other items used in the operations of the company
• Intangible and other assets—patents, trademarks, franchise rights, goodwill, and other items that provide future benefits, but do not possess physical substance

Question 4

Liabilities

Answer 4

Borrowed funds such as:
- Accounts payable
- Accrued liabilities
- Obligations to lenders,
bond investors, suppliers

Question 5

Equity

Answer 5

Capital that has been invested by shareholders, either:

• Directly via stock purchase, or
• Indirectly in the form of retained earnings that reflect earnings that are reinvested in the business

Question 6

Conditions which need to be met to report liabilities

Answer 6

1. A future sacrifice is probable.
2. The amount of the obligation is known or can be reasonably estimated.
3. The transaction or event that caused the obligation has occurred.

Executory contract -> conditions 1 and 2 are met -> No liability reported.

Question 7

Current liabilities

Answer 7

Reported as current liabilities on the balance sheet if due within one year and are listed in order of maturity.

Types:

• Accounts payable—amounts owed to suppliers for goods and services purchased on credit
• Accrued liabilities—obligations for expenses that have been recorded but not yet paid
• Short-term borrowings—short-term debt payable to banks or other creditors
• Deferred (unearned) revenue—an obligation created when the company accepts payment in advance for goods or services it will deliver in the future
• Current maturities of long-term debt—the portion of long-term debt that is due to be paid within one year.

Question 8

Non-current liabilities

Answer 8

Reported as long-term liabilities on the balance sheet if not due within one year or one operating cycle.

Types:

• Long-term debt—amounts borrowed from creditors that are scheduled to be repaid more than one year in the future
• Other long-term liabilities—various obligations, such as warranty and deferred compensation liabilities, long-term tax liabilities

Question 9

What is an account?

Answer 9

A record of increases and decreases for each asset, liability, equity, revenue, or expense.

Chart of accounts -> Listing of account titles and identification codes

Question 10

What accounts are affected by the transaction?

Answer 10

Must affect at least two accounts to maintain equality

Question 11

Did revenues and expenses increase or decrease the net assets of the company?

Answer 11

Revenues -> Increases in net assets that are earned by delivering goods and services to customers.

Expenses -> Decreases in net assets from generating revenue and supporting operations.