Chapter 2: Detailed Financial Statements

Question 1

4 Types of Assets

Answer 1

1) Current Assets (used within 1 year)
2) Long-term Investments (investments in stocks and bonds > than 1 year, assets not currently in use)
3) Property Plant and Equipment (assets with long lives currently used by a business, includes depreciation = allocating cost of assets to number of years
4) Intangible Assets (Assets that do not have physical substance: patents, copyright, trademarks)

Question 2

5 Types of Current Assets

Answer 2

1. Cash
2. Short-term investments
3. Accounts receivable
4. Inventories
5. Prepaid expenses and other current assets

Question 3

3 Types of liabilities and stockholder’s equity

Answer 3

1) Current Liabilities
2) Long-term liabilities (obligations company expects to pay after 1 year)
3) Stockholder’s equity: Common stock and retained earnings

Question 4

Ratio Analysis

Answer 4

A technique that expresses the relationship among selected items of financial statement

Question 5

3 types of ratio analysis

Answer 5

1) Profitability ratio: Measures success (EPS)
2) Liquidity: Ability to pay short-term obligations (working capital and current ratio)
3) Solvency: Ability to survive (Debt to assets ratio want to be low %, free cash flow)

Question 6

Earnings Per Share (EPS) Profitability

Answer 6

Net income minus preferred dividends divided by the weighted‐average number of common shares outstanding during the year (Price of common stock beginning of year - price of common stock end of year divided by 2)

Question 7

Working capital (liquidity)

Answer 7

Current assets - current liabilities

Question 8

Current ratio (liquidity)

Answer 8

Current assets/current liabilities

Question 9

Debt to assets ratio (solvency)

Answer 9

Total liabilities/total assets

Question 10

Free cash flow

Answer 10

Net cash - capital expenditures - cash dividends

Question 11

4 Accounting assumptions

Answer 11

1) Monetary Unit: Requires that only those things that can be expressed in money are included in the accounting records
2) Economic entity: Every economic entity can be separately identified and accounted for
3) Periodicity: The life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared for the business
4) Going concern: The company will continue in operation for the foreseeable future

Question 12

5 Measurement Principles

Answer 12

1. Historical Cost: States that companies should record assets at their cost
2. Fair Value: Assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability)
3. Full Disclosure: Companies disclose circumstances and events that make a difference to financial statement users
4. Cost Benefits/constraints: Constraint that weighs the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available.
5. Materiality: Whether an item is large enough to likely influence the decision of an investor or creditor

Question 13

Faithful Representation, information must be (3 things)

Answer 13

1. Complete
2. Neutral
3. Free from error

Question 14

Comparability

Answer 14

Ability to compare the accounting information of different companies because they use the same accounting principles.

Question 15

Consistency 

Answer 15

Use of the same accounting principles and methods from year to year within a company.

Question 16

Current assets

Answer 16

Assets that companies expect to convert to cash or use up within one year or the operating cycle, whichever is longer

Question 17

Current liabilities

Answer 17

Obligations that a company expects to pay within the next year or operating cycle, whichever is longer

Question 18

Long‐term investments

Answer 18

Generally:

1) investments in stocks and bonds of other corporations that companies hold for more than one year
2) long‐term assets, such as land and buildings, not currently being used in the company’s operations
3) long‐term notes receivable.

Question 19

Long‐term liabilities (long‐term debt)

Answer 19

Obligations that a company expects to pay after one year.

Question 20

Operating cycle

Answer 20

The average time required to purchase inventory, sell it on account, and then collect cash from customers—that is, go from cash to cash.

Question 21

Liquidity 

Answer 21

The ability of a company to pay obligations that are expected to become due within the next year or operating cycle

Question 22

3 qualities of information

Answer 22

1. Relevance: Indicates the information makes a difference in a decision
2. Timely: Information that is available to decision‐makers before it loses its capacity to influence decisions
3. Verifiable: The quality of information that occurs when independent observers, using the same methods, obtain similar results