Chapter 2--The Basic Financial Statements

Question 1

According to FASB, what constitutes the complete set of financial statements?

Answer 1

1. Financial position at the end of the period
2. Cash flows for the period
3. Earnings for the period
4. Comprehensive income for the period
5. Investments by and distributions to owners during the period

Question 2

What is an asset?

Answer 2

Economic resources or a firm, used to produce future cash inflow

Question 3

What is a liability?

Answer 3

Debts of an enterprise, usually used to acquire assets

Question 4

What is owners’ equity?

Answer 4

The residual claims of owners on the assets of a firm. The net assets of a firm after debts are accounted for–what an owner would take from the company if it closed and all debts were paid

Question 5

What is the accounting equation?

Answer 5

Assets = liabilities + owners’ equity
or
Resources of an enterprise = claims on the resources
or
Assets = sources of assets
or
(Current Assets + Non-Current Assets) = (Current Liabilities +Non-Current Liabilities + Owners’ Equity)

Question 6

What goes in the heading of a financial statement?

Answer 6

The company’s name, the name of the financial statement, and the date.

Question 7

What does the balance sheet contain?

Answer 7

Assets, Liabilities, and Owners’ Equity–a snapshot in time

Question 8

What is a current asset?

Answer 8

Assets that are expected to be converted into cash within a year as a result of the day-to-day operations

Question 9

What is a current liability?

Answer 9

A liability that is expected to be paid within one year

Question 10

What does the “Cash” account include on the balance sheet?

Answer 10

Cash on hand, checks on hand, cash in the bank, short term marketable securities

Question 11

What does the “Accounts Receivable” asset include on the balance sheet?

Answer 11

Cash due from customers who have purchased goods or services on credit, with allowances made for noncollectable accounts

Question 12

What is the “Inventory” asset on the balance sheet?

Answer 12

Cost of the inventory on hand

Question 13

What is the adjusted equipment cost?

Answer 13

Acquisition cost less depreciation

Question 14

Are land and buildings listed at purchase price or current market price?

Answer 14

Whichever is lower (conservatism principle)

Question 15

What does the “Accounts Payable” liability include on the balance sheet?

Answer 15

The amount owed to suppliers or goods and services

Question 16

How is “Owners’ Equity” divided on the Balance Sheet?

Answer 16

Capital stock and retained earnings

Question 17

What is capital stock?

Answer 17

The amount owners have directly invested in the company, at the time of purchase of stock

Question 18

What are retained earnings?

Answer 18

Total cumulative amount of earnings the company has retained and invested in its operations

Question 19

What does the income statement contain?

Answer 19

Revenues and expenses from a given period, to provide information for the evaluation of a company’s financial performance over a period of time

Question 20

What is a revenue?

Answer 20

Income earned for providing a good or service–cause owners’ equity to increase

Question 21

What is an expense?

Answer 21

Costs incurred by the process of generating revenues–cause owners’ equity to decrease

Question 22

How is the net income for a period calculated?

Answer 22

Total revenue for a period less the total expense for that same period

Question 23

What is the accrual method of accounting?

Answer 23

That revenues and expenses are recognized only during the period they were performed, regardless of whether money actually changed hands during that period

Question 24

What is the cash method of accounting?

Answer 24

That revenue and expenses are recognized only when cash changes hands

Question 25

What is the cost of goods sold on an income statement?

Answer 25

The actual cost of acquiring and selling (salesmen wages included!) the goods that were sold

Question 26

What is the Gross Margin?

Answer 26

The difference between the firm’s net sales and the cost of goods sold

Question 27

What are included in Operating Expenses on an income statement?

Answer 27

Rent, utilities, insurance, salaries, advertising, promotion, costs of running the administrative office

Question 28

What is Income from Operations?

Answer 28

Gross Margin less Operating Expenses

Question 29

What is Net Income on an Income Statement?

Answer 29

The total amount earned after all expenses have been accounted for–the change in the owners’ equity for the period

Question 30

What is the purpose of the Statement of Retained Earnings?

Answer 30

To show how Net Income was used over a period, either to pay as dividends to owners, or reinvested into the company as retained earnings

Question 31

Are Dividends considered an expense?

Answer 31

No, so they do not show up on the Income Statement

Question 32

What types of activities are included in Retained Earnings?

Answer 32

Sales
Cost of Goods Sold
Salaries
Interest Expense