Chapter 1

Question 1

What is the difference between managerial and financial accounting?

Answer 1

• Managerial Accounting - the area that serves the decision-making needs of internal uses
• Financial Accounting - is the area that presents financial information of interest to external uses

Question 2

What is the difference between a business organization and a non- business organization?

Answer 2

• Business - sells products or services for a profit
• Non-Business - (ie: charity, hospital) exist to meet various societal needs and does not profit as a goal.

Question 3

What are the three types of business organizations?

Answer 3

1) Proprietorship - owned by 1 person
2) Partnership - owned by 2 or more individuals
3) Corporation - owned by one or more shareholders

Question 4

What is a publicly accountable enterprise (PAE) vs a private enterprise (PE)?

Answer 4

• PAE - a business that shares stocks publicly, typically in a stock exchange.
• PE - a business that holds its shares privately

Question 5

What does the term limited liability mean?

Answer 5

The shareholders of a corporation are NOT responsible for the corporations debts. Meaning that the most a shareholder can lose is only what they have invested in the corporation

Question 6

Describe what GAAP refers to.

Answer 6

General Accepted Accounting Principles - these are the guidelines for financial accounting used in any given jurisdiction. It includes the standards and commonly agreed to practices that accountants follow in recording and summarizing financial information AND in the preparation of financial statements

Question 7

Identify and explain the six qualitative characteristics of GAAP.

Answer 7

1) Relevance - the ability to make a difference in the decision-making process
2) Faithful Representation - providing information that is complete, neutral and error free
3) Comparability - reporting similar information across similar entities in a similar manner
4) Verifiability - ability of an independent observer to reproduce the same financial information given the same input data and assumptions
5) Timelessness - providing new information to decision makers while it is still useful
6) Understandability - presenting information in a manner that is clear and concise.

Question 8

What is the general purpose of financial statements? What are the
four types of financial statements?

Answer 8

Financial Statements evaluate the performance of an entity and measure its progress. This is done by collecting, summarizing & reporting financial information in these statements. The 4 types are:
1) Statement of financial position
2) Income statement
3) Statement of cash flows
4) Statement of changes in equity

Question 9

What is the purpose of an income statement vs a statement of financial position? How to they interrelate?

Answer 9

• Income Statement = communicates the inflow of assets (in the form of revenue) and the outflow or consumption of assets (in the form of expenses) OVER A PERIOD OF TIME. Total inflows > total outflows = net income (profit). This is reported on the income statement and in retained earnings in the shareholders equity section of the next statement (statement of financial position)
• Statement of Financial Position = communicates what the entity owns (assets) what the entity owes (liabilities) and the difference between those two (the equity) at a SPECIFIC POINT OF TIME

Question 10

Define the terms “revenue” and “expense”

Answer 10

• Revenue - an increase in an entities assets or a decrease in liabilities in return for services performed or good sold.
• Expense - an asset that is used up or obligations incurred in selling thus goods or performing those services

Question 11

What is net income? What information does it convey?

Answer 11

Net Income is the difference between revenue & expenses (one way to measure the success of an entity)

Question 12

What is the purpose of a statement of changes in equity?

Answer 12

Statement of Changes of Equity - shows why share capital and retained earnings have changed over a specific period of time (such as when shares are issues or net income is earned)

Question 13

Shareholder’s equity consists of which 2 components? Explain them

Answer 13

• Shared Capital - refers to how much shareholders have invested initially
• Retained Earnings - refers to the sum of all the net incomes earned (or net losses incurred) by a corporation over its entire life (minus any distributions of net income to shareholders)

Question 14

Explain how retained earnings and dividends are related

Answer 14

Dividends are the distributions of the retained earnings TO shareholders

Question 15

What are the 3 primary components of the statement of
financial position?

Answer 15

Assets = Liabilities + Shareholder’s Equity

Question 16

What are assets?

Answer 16

Assets are anything of value that is owned by the entity. They are economic resources controlled by the entity. They have some future value and are usually used for the generation of revenue

Question 17

What do the terms liability & shareholders equity refer to?

Answer 17

• Liability: 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
• Shareholders Equity: represents the amount of assets owing to the owners of the entity. The total assets of an entity belong either to the shareholders or the creditors

Question 18

What information is provided in the statement of cash flows?

Answer 18

Statement of Cash Flow explains how cash reported on the statement of financial position 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 in the SCF, such as long-lived assets or repayment of debt

Question 19

What are notes to the financial statements?

Answer 19

Notes provide greater detail about various amounts shown in the financial statements OR provide non-quantitative information that is useful to users, such as loan repayment terms.

Question 20

Explain how the double-entry accounting system works.

Answer 20

Double-Entry Accounting System is used to record financial transactions. Each transaction affects at least 2 items in the accounting equation in order to maintains its equality.

Question 21

Why are financial statements prepared at regular intervals? Who
are the users of these statements?

Answer 21

They are done at regular intervals so as to keep a number of interested groups informed of the financial performance of the corporation. The timing is determined in response to the needs of the management in their running of the entity OR of outside parties such as bankers and shareholders. The external users can then make lending or investing decisions by, in part, basing them off of these financial statements

Question 22

What is the basic accounting equation? How does it work?

Answer 22

ASSETS = LIABILITIES + SHAREHOLDER EQUITY
The entity has resources it owns (assets). These assets must always equal the total claims of creditors (liabilities) & owners who have residual claims (shareholder equity)

Question 23

Explain what is meant by the term “financial transaction”. Give an
example.

Answer 23

A Financial Transaction is an exchange of assets or obligations by an entity expressed in monetary terms.
Ex: exchange of cash for land or a building