Chapter 2: A further look in financial statements

Question 1

Accounts payable

Answer 1

Amounts owed to suppliers for purchases made on credit (on account).

Question 2

Accounts receivable

Answer 2

Amounts owed by customers who purchased products or services on credit (on account).

Question 3

Bank indebtedness

Answer 3

A short-term loan, such as an operating line of credit, pre-arranged with a bank to cover cash shortfalls.

Question 4

Basic earnings per share (EPS)

Answer 4

A measure of profitability showing the income earned by each common share. It is calculated by dividing income available to common shareholders by the weighted average number of common shares.

Question 5

Comparability

Answer 5

An enhancing qualitative characteristic of useful information that enables users to identify and understand similarities in, and differences among, items.

Question 6

Conceptual framework

Answer 6

A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting statements.

Question 7

Contra asset account

Answer 7

An account that is off set against (reduces) another related asset account on the statement of financial position. Examples include allowance for doubtful accounts and accumulated depreciation.

Question 8

Cost constraint

Answer 8

The pervasive constraint that ensures that the value of the information provided in financial reporting is greater than the cost of providing it.

Question 9

Current assets

Answer 9

Assets that are expected to be converted into cash, sold, or used up within one year of the company’s financial statement date.

Question 10

Current liabilities

Answer 10

Obligations that will be paid or settled within one year of the company’s financial statement date.

Question 11

Current maturities of long-term debt

Answer 11

The portion of a non-current or long-term loan that is repayable within the current year.

Question 12

Current ratio

Answer 12

A measure of liquidity used to evaluate a company’s short-term debt-paying ability. It is calculated by dividing current assets by current liabilities.

Question 13

Current value (also known as fair value or current cost)

Answer 13

The price that would be paid to purchase the same asset or paid to settle the same liabilities.

Question 14

Current value basis of accounting

Answer 14

Measurement basis that states that certain assets and liabilities should be recorded at their current value.

Question 15

Debt to total assets

Answer 15

A measure of solvency showing the percentage of total financing that is provided by lenders and other creditors. It is calculated by dividing total liabilities by total assets.

Question 16

Elements of financial statements

Answer 16

A set of broad categories or classes used to group financial information for presentation in the financial statements, such as assets, liabilities, equity, income, and expenses.

Question 17

Faithful representation

Answer 17

A fundamental qualitative characteristic describing information that represents economic reality. It must be complete, neutral, and free from material error.

Question 18

Going concern assumption

Answer 18

The assumption that the business will remain in operation for the foreseeable future.

Question 19

Held for trading investments

Answer 19

Investments in debt securities or equity securities of other companies that are bought with the intention of selling them after a short period of time in order to earn income from their price fluctuations.

Question 20

Historical cost basis of accounting

Answer 20

Measurement basis that states that assets and liabilities should be recorded at their cost at the time of acquisition.

Question 21

Intangible assets

Answer 21

Assets of a long-lived nature that do not have physical substance but represent a privilege or a right granted to, or held by, a company.

Question 22

Inventory

Answer 22

Goods held for sale to customers

Question 23

Liquidity ratios

Answer 23

Measures of a company’s shortterm ability to pay its maturing obligations (usually current liabilities) and to meet unexpected needs for cash. These include working capital and the current, receivables turnover, average collection period, inventory turnover, and days in inventory ratios.

Question 24

Long-term investments

Answer 24

Investments in debt securities intended to be held for many years to earn interest, and (2) equity securities of other companies held to generate investment revenue or held for strategic reasons.

Question 25

Long-term assets

Answer 25

Assets that are not expected to be converted into cash, sold, or used up by the business within one year of the financial statement date.

Question 26

Long-Term Liabilities

Answer 26

Obligations that are not expected to be paid or settled within one year of the financial statement date.

Question 27

Notes payable

Answer 27

Amounts owed to suppliers, banks, or others that are normally interest-bearing and supported by a written promise to repay.

Question 28

Notes receivable

Answer 28

Amounts owed by customers or others that are normally interest-bearing and supported by a written promise to repay.

Question 29

Objective of financial reporting

Answer 29

The provision of financial information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company.

Question 30

Operating cycle

Question 31

Prepaid expenses

Answer 31

Costs paid in advance of use that benefit more than one accounting period. They are initially recorded as assets and become expenses only when they are used or consumed and no longer have future benefit.

Question 32

Price-earnings (P-E) ratio

Answer 32

A profitability measure of the ratio of the market price of each common share to the earnings per share. It reflects investors’ beliefs about a company’s future income potential.

Question 33

Profitability ratios

Answer 33

Measures of a company’s operating success for a specific period of time. These include the gross profit margin, profit margin, return on assets, return on common shareholders’ equity, earnings per share, price-earnings, payout, and dividend yield ratios.

Question 34

Property, plant, and equipment

Answer 34

Tangible assets, such as land, buildings, and equipment, with relatively long useful lives that are being used to operate the business.

Question 35

Relevance

Answer 35

A fundamental qualitative characteristic describing information that makes a difference in a user’s decision. It should have predictive value, confirmatory value, or both, and be material.

Question 36

Solvency ratios

Answer 36

Measures of a company’s ability to survive over a long period of time by having enough assets to settle its liabilities as they fall due. These include the debt to total assets and times interest earned ratios and free cash flow.

Question 37

Supplies

Answer 37

Consumable items used in running a business, such as office and cleaning supplies.

Question 38

Timeliness

Answer 38

An enhancing qualitative characteristic of useful information that means that information is available to decision makers in time to be capable of influencing their decisions.

Question 39

Understandability

Answer 39

An enhancing qualitative characteristic of useful information that means that information is clearly and concisely classified, characterized, and presented.

Question 40

Unearned revenue

Answer 40

Cash received when a customer pays in advance of being provided with a service or product. It is received before revenue is earned and is therefore recorded as a liability until it is earned.

Question 41

Verifiability

Answer 41

An enhancing qualitative characteristic of useful information that means that different knowledgeable and independent users could reach a consensus that the information is faithfully represented.

Question 42

Working capital

Answer 42

A measure of liquidity used to evaluate a company’s short-term debt-paying ability. It is calculated by subtracting current liabilities from current assets.