Chapter 2 Balance Sheet

Question 1

Net Worth - Individual

Balance Sheet Equation

Answer 1

The difference between what you have and what you owe.
Total assets less liabilities
A - L = NW

Question 2

Balance Sheet Equation

Lenders Relationship

Answer 2

Creditors have a claim on listed assets, they are in a less risky position
A = L + NW

Question 3

Balance Sheet Equation

Shareholder Relationship

Answer 3

Shareholders (those that purchase ownership shares in the business) have the last claim on the corporate assets listed on the balance sheet.
A = L + SE

Question 4

Financing Decision

Answer 4

Some companies borrow sparingly and thus are financed principally by shareholders. Other companies borrow extensively (referred to as leveraged)

The relative mix of funding between shareholders and lenders can have a dramatic effect on a firms financial performance.

Question 5

Asset

Answer 5

An economic resource that is expected to generate future benefits for a business

Question 6

Liability

Answer 6

An obligation to make future payments

Question 7

Off-Balance Sheet liabilities

Answer 7

Liabilities that are often not reported on the balance sheet

Question 8

Shareholders Equity

Answer 8

Residual value of a business - Value of any assets remaining after all liabilities have been satisfied

CS + RE = SE

Question 9

Common Stock (CS)

Answer 9

Value of the shareholders direct investment in a business

Question 10

Retained Earnings (RE)

Answer 10

Amount of any profits retained in the business to support future operations

Question 11

Issuing Shares

Answer 11

The number of shares issued by a company and their related value. The amount of money given for a set of shares becomes the basis for the starting equity value

Question 12

Entity Principle

Answer 12

This principle stipulates that the financial affairs of a business must be maintained separate and distinct from the affairs of the owners of the business

Question 13

Accrual Basis of accounting

Answer 13

Any interest owed but not paid will be recorded as necessary at future balance sheet dates with an appropriate charge to earnings and retained earnings

Question 14

Tangible Assets

Answer 14

Most recorded assets such as buildings have an actual physical presence

Question 15

Intangible Assets

Answer 15

Include such items as patents, copyrights and brand names

Question 16

Forecasted Financial Statement

Answer 16

Financial statements prepared on an “as if” bases using assumptions about what might happen in the future

Question 17

Opportunity Cost

Answer 17

Extending credit to customers. Equal to the cost of borrowing over the time period during which the purchase price remains unpaid

Question 18

Historical Cost Principle

Answer 18

Stipulates that all assets should initially be recorded at their historical acquisition cost

Question 19

Relation between Revenues and Expenses

Answer 19

Revenues - which increase net income also increase retained earnings
Expenses - Decrease net income and also decreases retained earnings
We include income statement accounts as subcomponents of retained earnings

Question 20

Revenue Recognition Principle

Answer 20

Recognizing revenue is a wealth-increasing event for a business and its shareholders and this is reflects by an increase in shareholders equity (through the retained earnings account).

Question 21

Expenses

Answer 21

Represent the using up of goods and services associated with the production of revenues by a business. Expenses reduce assets or increase liabilities, expenses are a wealth-reducing event

Question 22

Matching Concept

Answer 22

Within a given accounting period, a business is able to convey its accomplishments (revenue) with its efforts (expenses)

Question 23

Contra Accounts (CA)

Answer 23

Balance Sheet accounts that are subtracted from other accounts (such as accumulated depreciation)

Question 24

Net Book Value

Answer 24

The difference between the cost of an asset (eg equipment) and its accumulated depreciation

Question 25

Depreciation

Answer 25

Refers to the systematic expensing of an asset as a consequence of the passage of time
Asset = Accumulated Depreciation
Shareholder Equity = Depreciation

Question 26

Amortization

Answer 26

The write-off of the purchased brand name

-Just estimates, and as such, can be quite imprecise

Question 27

Additional Shares

Answer 27

The issuance of additional common shares increase SE. As a consequence of selling shares to the outside investor, the owners must share control of the business and its profits with the investor who has become co-owner

Question 28

Income Tax

Answer 28

cost of doing business. This expense must be matched with the company’s revenue

Question 29

Balance Sheet Includes…

Answer 29

The income statement accounts
Ex. Revenues, COGS, Wages and Salaries, Selling and Administrative, Depreciation, Amortization, Interest expense, income tax, dividends all under Retained Earnings

Question 30

Preparing the Financial Statements

Answer 30

Summing up the various values in each of the rows. These final balances are entered in the final column labeled “ending balance”.

Question 31

Current Assets

Answer 31

Those assets that are expected to be converted into cash or used to support operations during the next 12 months

Question 32

Noncurrent Assets

Answer 32

Those assets expected to be available to support the coninuing operations of a business beyond 12 months

Question 33

Current Liabilities

Answer 33

those liabilities that are expected to require payment within the next 12 months

Question 34

Noncurrent Liabilities

Answer 34

Obligations that not expected to require payment for more than one year. The phrase “long-term” is often used instead of “noncurrent”.

Question 35

Revenue

Answer 35

Measure the inflow of cash and other assets (such as accounts receivable) from a firms primary business activity.

Question 36

Gross Profit

Answer 36

Measures the amount of cash and assets remaining after deducting the cost of sales (COGS)

Question 37

Operating Income

Answer 37

Refers to a firms net income before deducting such items as interest expense and income taxes

Question 38

Net Income

Answer 38

The firms bottom-line performance - the company’s net income after all expenses are deducted, both operating and nonoperating, recurring or non-recurring

Question 39

Recurring Operations

Answer 39

core business of producing and selling product

Question 40

Evaluating Firm Profitability

Answer 40

To evaluate the profitability of a business, it is often useful to consider various performance indicators from the financial statement’s

Question 41

Return on Sales (ROS)

Answer 41

One profitability measure that considers relative firm size.

AKA Net income divided by sales revenue

Question 42

Return on Assets (ROA)

Answer 42

Another measure of profitability that considers relative firm size.
Net income plus after tax interest expense divided by total assets

Question 43

Tax Shield

Answer 43

Positive impact of interest expense on a firms income tax expense.

The amount of interest added back to net income should be reduced by the amount of the tax shield which is already reflected in a firms income tax provision