Module 9

Question 1

What is a balance sheet?

Answer 1

a financial statement that reports the types and the monetary amounts of a business’s assets, liabilities and owner’s equity on a specific date

Question 2

What does the balance sheet do?

Answer 2

• Provides information that helps internal and external users to evaluate a business’s ability to achieve its primary goals of earning a satisfactory profit and remaining solvent.
• They prepare it at the end of each accounting period, or any other time to give a current snapshot of the business’s financial position

Question 3

What are the features of a balance sheet?

Answer 3

a. Balance sheet presents a business’s financial position on a specific date, allowing users to ‘take stock’ of a business’s assets, liabilities and owner’s equity on that date.
b. Managers and external users need this financial-position information in order to make business decisions.
c. They can find out how much money customers owe the business (accounts receivable), see the total dollar amount of the inventory on hand at year-end and discover how much money the business owes its creditors (accounts payable).

Question 4

Why do users need both the balance sheet and the income statement?

Answer 4

If either financial statement is missing, it is much more difficult to predict how well the business will perform.
eg. You would want to know whether the business had the assets, liabilities and owner’s equity (the ‘ingredients’) needed to earn a satisfactory profit (to bake a delicious loaf of bread).
You would also need to know whether the business had been able to use its resources in the past to earn such a profit (has it baked delicious bread before?).

Question 5

What is a limitation of the income statement and balance sheet?

Answer 5

1. Historical concept doesn’t always show each assets current value
2. They do not provide much information about a business’s cash management because they are based on accrual accounting. Hence investors and creditors also need a financial statement that provides a summary of a business’s cash flows during an accounting period. (cash flow statement)

Question 6

What are current assets?

Answer 6

cash and other assets that the business expects to convert into cash, sell or use up within one year. They include:

Question 7

What are assets?

Answer 7

business’s economic resources that it expects will provide future benefits to the business. There are four types of assets.

Question 8

What are some types of current assets?

Answer 8

1. Cash
2. Marketable securities
3. Receivables
4. Inventory
5. Prepaid items

Question 9

What are marketable securities?

Answer 9

Sometimes called temporary investments or short-term investments, are items such as government bonds and capital stock of companies in which the business has temporarily invested and which the business expects to sell within a year.

Question 10

What are notes receivables?

Answer 10

Related interest

Question 11

What are examples of prepaid items?

Answer 11

insurance, rent, office supplies and shop supplies will not be converted into cash, but will be used up within one year

Question 12

What are non-current assets?

Answer 12

a business must intend to hold the investment for more than one year to classify it in the non-current assets section of the balance

Question 13

What is property and equipment?

Answer 13

include all the physical, long-term assets used in the operations of a business. They are recorded at the carrying amount or book value.

Question 14

What is carrying amount?

Answer 14

carrying amount = original cost - accumulated depreciation

Question 15

What are intangibles?

Answer 15

assets that do not have a tangible or physical substance, but the ownership of which entitles the owner to future economic benefits.

Question 16

What are liabilities?

Answer 16

the economic obligations (debts) of a business.

Question 17

What are creditors?

Answer 17

the external parties to whom the business owes the economic obligations

Question 18

What are the two types of liabilities?

Answer 18

1. Current liabilities

2. Non-current liabilities

Question 19

What are current liabilities?

Answer 19

obligations that the business expects to pay within one year by using current assets. They are usually listed in their order of liquidity.

Question 20

What are the types of current liabilities?

Answer 20

1. Accounts payable and salaries payable
2. Unearned revenue
3. Short term loans and notes payable
4. Provisions

Question 21

What are accounts payable and salaries payable?

Answer 21

money owed to suppliers and employees

Question 22

What are unearned revenues?

Answer 22

advance collections from customers for the future delivery of goods or the future performance of services (for services or goods not provided yet)

Question 23

What are short term loans and notes payable?

Answer 23

obligations that arise because a business signs a note (legal documents) that it will pay within one year

Question 24

What are provisions?

Answer 24

liabilities of uncertain timing or amount eg. bad debts or long service leave

Question 25

What are non-current liabilities?

Answer 25

obligations that a business does not expect to pay within the next year (long-term liabilities)

Question 26

What are the types of non-current liabilities?

Answer 26

1. Long term note payable
2. Loans payable
3. Bonds payable

Question 27

What are long term notes payable?

Answer 27

an agreement a company enters into with another party and includes a formal written promise to pay predetermined amounts on specific dates

Question 28

What are loans payable?

Answer 28

money that has been borrowed and needs to be paid back

Question 29

What are bonds payable?

Answer 29

contains the amount owed to bond holders by the issuer.
They mostly incur a long term liability because when it purchases property or equipment, it finances the purchase by borrowing the money to buy the item, and then pays back the amount borrowed over a period longer than a year.

Question 30

What is owner’s equity?

Answer 30

the owner’s current investment in the assets of the business

Question 31

What does owner’s equity consist of?

Answer 31

a. Retained earnings

b. Owner’s capital

Question 32

what does the balance sheet list for a sole proprietorship under owner’s equity?

Answer 32

For a sole proprietorship, the balance sheet lists the total ending owner’s equity in a single capital account – this account is affected by the owner’s additional investment, withdrawals and by net income

Question 33

What does a company’s balance sheet refer under owner’s equity?

Answer 33

A company’s balance sheet refers to shareholder’s equity rather than owner’s equity.
Shareholders’ equity has two components:
a. Contributed capital (shared capital)
b. Retained earnings –

Question 34

What are retained earnings?

Answer 34

Profits left in the business less any dividends distributed, which are the shareholders

Question 35

What is liquidity?

Answer 35

how quickly a business can convert its assets into cash to pay its bills

Question 36

Why is liquidity important?

Answer 36

• It is an important financial characteristic because to remain solvent, a business must have cash
• External users assess how well a business manages its liquidity by studying its working capital.

Question 37

What is the current ratio?

Answer 37

current assets/current liabilities

Question 38

Why is current ratio important?

Answer 38

The current ratio is more useful than working capital for measuring a business’s liquidity because the current ratio allows comparisons of different-sized businesses.
The current ratio helps predict a business’s ability to continue to purchase inventory.

Question 39

What do different current ratio values indicate?

Answer 39

• A current ratio that is lower than the industry average may indicate a higher risk of distress or default.
• Similarly, if a company has a very high current ratio compared to its peer group, it indicates that management may not be using its assets efficiently.

Question 40

What is the quick ratio?

Answer 40

Quick assets/current liabilities

Question 41

What are quick assets?

Answer 41

current assets that may be easily converted into cash. Quick assets consist of:

a. Cash
b. Short term marketable securities
c. Accounts receivable
d. Short term notes receivable

Question 42

Why is quick ratio important?

Answer 42

a. It is a more convincing indicator of a business’s short term debt paying ability
b. Short-term lenders often use this ratio when deciding whether to extend credit
c. The quick ratio shows potential liquidity problems when a business has a poor mix of current assets.

Question 43

What is the debt ratio?

Answer 43

Total liabilities/Total assets

Question 44

Why is the debt ratio important?

Answer 44

a. Used to evaluate financial flexibility (ability of a business to adapt to change). This is because a higher debt ratio indicates that a business may not be able to borrow money to adapt to business opportunities.
b. Used by creditors - lower debt ratio indicates that the business is more likely to be able to pay the interest it owes as well as its other fixed costs
c. The debt ratio helps evaluate whether a business has the resources to replace property and equipment.

Question 45

What is operating capability?

Answer 45

refers to a business’s ability to sustain a given level of operations

Question 46

What is the return on total assets?

Answer 46

(net income + interest expense)/average total assets

Question 47

What is return on owner’s equity?

Answer 47

net income/average owner’s equity

Question 48

What is inventory turnover ratio?

Answer 48

cost of goods sold/average inventory

Question 49

What does inventory turnover values indicate?

Answer 49

As a general rule, the higher the inventory turnover, the more efficient the business is in its purchasing and sales activities, and the less cash it needs to invest in inventory.

Question 50

How do you calculate number of days in selling period?

Answer 50

number of days in business year/inventory turnover

Question 51

What is the accounts receivable turnover ratio?

Answer 51

net credit sales/average accounts receivable

Question 52

What does accounts receivable turnover ratio indicate?

Answer 52

Accounts receivable turnover measures how efficiently a business collects cash from its credit customers.
Users prefer to see a higher turnover, which shows that the business has less cash tied up in accounts receivable, collects this cash faster and, usually, has fewer customers who don’t pay.