Unit 1

Question 1

What is the objective of general purpose financial reporting?

Answer 1

The objective of general-purpose financial reporting is to report financial information that is useful in making decisions about providing resources to the reporting entity.

Question 2

How can reporting information about financial performance be useful?

Answer 2

Information about financial performance is useful for:

1) Understanding the return on economic resources, its variability, and its components

2) Evaluating management

3) Predicting future returns

Question 3

What set of financial reporting standards is most commonly used in the United States?

Answer 3

The set of financial reporting standards most commonly used in the United States is U.S. Generally Accepted Accounting Principles (GAAP).

Question 4

Why do external users use financial statements?

Answer 4

External users use financial statements to determine whether doing business with the firm will be beneficial.

Question 5

Why do internal users use financial statements?

Answer 5

Internal users use financial statements to make decisions affecting the operations of the business.

Question 6

What constitutes a full set of financial statements?

Answer 6

A full set of financial statements includes a(n):

1) Statement of financial position (balance sheet)

2) Income statement

3) Statement of comprehensive income

4) Statement of changes in equity

5) Statement of cash flows

Question 7

What is the going-concern assumption?

Answer 7

The going-concern assumption is the assumption that the entity will continue operating indefinitely and will not be liquidated in the near future.

Question 8

What is the accrual basis of accounting?

Answer 8

Accrual accounting records the financial effects of transactions and other events and circumstances when they occur rather than when their associated cash is paid or received.

Question 9

What items are reported on the statement of financial position (balance sheet)?

Answer 9

The statement of financial position reports amounts of:

1) Assets,

2) Liabilities, and

3) Equity.

Question 10

What is the basic accounting equation?

Answer 10

Assets = Liabilities + Equity

Question 11

Define assets.

Answer 11

Assets are resources controlled by the entity as a result of past events. They represent probable future economic benefits to the entity.

Question 12

Define liabilities.

Answer 12

Liabilities are present obligations of the entity arising from past events. The settlement of liabilities is expected to result in an outflow of economic benefits.

Question 13

Define equity.

Answer 13

Equity is the residual interest in the assets of the entity after subtracting all its liabilities.

Question 14

When is a financial item classified as current?

Answer 14

An asset is current if it is expected to be realized in cash or sold or consumed within the entity’s operating cycle or 1 year, whichever is longer. A liability is current if it is expected to be settled or liquidated in the ordinary course of business within the longer of one year or one operating cycle.

Question 15

Current assets include

Answer 15

1) Cash and equivalents

2) Certain marketable securities

3) Receivables

4) Inventories

5) Prepaid expenses

6) Certain investments in equity securities

Question 16

Noncurrent assets include

Answer 16

1) Investments and funds

2) Property, plant, and equipment (PPE)

3) Intangible assets

Question 17

Current liabilities include

Answer 17

1) Accounts (or trade) payables

2) Other payables

3) Unearned revenues

4) Other short-term obligations

Question 18

Noncurrent liabilities include

Answer 18

1) Certain notes and bonds

2) Certain lease liabilities

3) Certain deferred tax liabilities

4) Product or service warranty agreements

5)Deferred revenue

6) Advances for noncurrent commitments to provide goods or services

Question 19

The major items of equity include

Answer 19

1) Capital contributions by owners

2) Retained earnings

3) Treasury stock

4) Accumulated other comprehensive income

Question 20

Limitations of the balance sheet include

Answer 20

1) The financial position reported is at a single point in time; accounts may vary soon before or after the balance sheet date.

2) Many items are reported at historical costs rather than fair value.

3) Balance sheet preparation requires estimates and management judgment.

4) Items that have financial value but cannot be recorded objectively are omitted from the statement.

Question 21

What is the income equation?

Answer 21

Income (Loss) = Revenues + Gains – Expenses – Losses

Question 22

Define revenues.

Answer 22

Revenues are inflows or other enhancements of assets or settlements of liabilities from delivering or producing goods, providing services, or other activities that qualify as ongoing major or central operations.

Question 23

Define gains.

Answer 23

Gains are increases in equity (or net assets) other than from revenues or investments by owners.

Question 24

Define expenses.

Answer 24

Expenses are outflows or other usage of assets or incurrences of liabilities from delivering or producing goods, providing services, or other activities that qualify as ongoing major or central operations.

Question 25

Define losses.

Answer 25

Losses are decreases in equity (or net assets) other than from expenses or distributions to owners.

Question 26

Define gross profit.

Answer 26

Gross profit is the net difference between sales revenue and cost of goods sold.

Question 27

What is the matching principle?

Answer 27

The matching principle states that the recognition of expense and its related revenue should occur in the same reporting period.

Question 28

In which format(s) may an income statement be presented?

Answer 28

An income statement may be presented using a single-step format or a multi-step format.

Question 29

How is a discontinued operation reported on the income statement?

Answer 29

The discontinued operation must be presented, net of tax, in a separate section between income from continuing operations and net income.

Question 30

Limitations of the income statement include

Answer 30

1) Items of income and expense may be omitted from the income statement and reported on the statement of other comprehensive income.

2) Financial statements report accrual-basis results for the period.

3) Preparing the income statement requires estimates and management judgment.

Question 31

Define comprehensive income.

Answer 31

Comprehensive income includes all changes in equity (net assets) of a business during a period except those from investments by and distributions to owners. It consists of net income (loss) and other comprehensive income (OCI).

Question 32

Major items omitted from net income but included in other comprehensive income include

Answer 32

1) The effective portion of a gain or loss on a hedging instrument in a cash flow hedge

2) Unrealized holding gains and losses due to changes in the fair value of available for sale debt securities

3) Translation gains and losses for financial statements of foreign operations

4) Certain amounts associated with accounting for defined benefit postretirement plans

Question 33

What are the acceptable presentation formats of other comprehensive income?

Answer 33

Other comprehensive income may be presented in either:

1) One continuous financial statement that has two sections or

2) Two separate but consecutive statements.

Question 34

What is the purpose of the statement of changes in equity?

Answer 34

The statement of changes in equity reconciles the beginning balance and ending balance for each component of equity for a given reporting period.

Question 35

How are changes in accounting principle and corrections of prior-period financial statement errors reported in financial statements?

Answer 35

These items require retrospective application and therefore are not included in the calculation of current-period net income.

Question 36

How are changes in accounting estimates reported in financial statements?

Answer 36

Changes in accounting estimates are not prior-period adjustments and require prospective application and therefore are included in the calculation for the period of change and for any future periods affected.

Question 37

What is the general entry to record the issuance of common stock?

Answer 37

Cash $XXX
Common stock $XXX
Additional paid-in capital $XXX

Question 38

What are the steps involved in declaring and distributing a property dividend?

Answer 38

1) Property to be distributed is remeasured to fair value as of the date of declaration, with any gain or loss on the remeasurement recognized in the statement of income.

2) Retained earnings is decreased by the fair value of the property to be distributed.

3) Property is distributed as a dividend.

Question 39

How is a stock dividend accounted for?

Answer 39

Stock dividends are accounted for as a reclassification of different equity accounts. The fair value of the additional shares issued is reclassified from retained earnings to common stock at par value, with the difference credited to additional paid-in capital.

Question 40

How is a stock split accounted for?

Answer 40

Stock splits are issuances of shares that do not affect any aggregate par value of shares issued and outstanding or total equity. The split reduces par value of each stock and increases the number of shares outstanding.

Question 41

Limitations of the statement of changes in equity include

Answer 41

1) Due to the accrual-basis, the retained earnings balance may not be reflective of the firm’s ability to reinvest, pay dividends, or pay debt.

2) Actual equity may vary significantly from the reported amount a few days before or after publication of the statement.

Question 42

What is the primary purpose of the statement of cash flows?

Answer 42

The primary purpose of the statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during the period. It also reconciles the period’s beginning and ending balances of cash and cash equivalents.

Question 43

Define operating activities.

Answer 43

Operating activities are all transactions and other events that are not financing or investing activities. They are the principal revenue-producing activities of the entity.

Question 44

What are the acceptable methods of presenting the statement of cash flows from operating activities?

Answer 44

The statement of cash flows from operating activities may be presented using either the direct or indirect method.

Question 45

Define investing activities.

Answer 45

Cash flows from investing activities represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

Question 46

Define financing activities.

Answer 46

Cash flows from financing activities generally involve the cash effects of transactions and other events that relate to the issuance, settlement, or reacquisition of the entity’s debt and equity instruments.

Question 47

Limitations of the statement of cash flows include

Answer 47

1) The statement is insufficient for forecasting the profitability of a firm as noncash items are not considered

2) The statement may not represent the true liquid position of the entity

3) Information in the statement can be manipulated.