Unit 1: External Financial Statements

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
Understanding the return on economic resources, its variability, and its components
Evaluating management
Predicting future returns

Question 3

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

Answer 3

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)
Statement of financial position (balance sheet)
Income statement
Statement of comprehensive income
Statement of changes in equity
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
Assets,
Liabilities, and
Equity

Question 10

Define assets.

Answer 10

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

Question 11

Define liabilities.

Answer 11

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 12

Define equity.

Answer 12

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

Question 13

When is a financial item classified as current?

Answer 13

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 14

Current assets include

Answer 14

Cash and equivalents
Certain marketable securities
Receivables
Inventories
Prepaid expenses
Certain investments in equity securities

Question 15

Noncurrent assets include

Answer 15

Investments and funds
Property, plant, and equipment (PPE)
Intangible assets

Question 16

Current liabilities include

Answer 16

Accounts (or trade) payables
Other payables
Unearned revenues
Other short-term obligations

Question 17

Noncurrent liabilities include

Answer 17

Certain notes and bonds
Certain lease liabilities
Certain deferred tax liabilities
Product or service warranty agreements
Deferred revenue
Advances for noncurrent commitments to provide goods or services

Question 18

The major items of equity include

Answer 18

Capital contributions by owners
Retained earnings
Treasury stock
Accumulated other comprehensive income

Question 19

Limitations of the balance sheet include

Answer 19

The financial position reported is at a single point in time; accounts may vary soon before or after the balance sheet date.
Many items are reported at historical costs rather than fair value.
Balance sheet preparation requires estimates and management judgment.
Items that have financial value but cannot be recorded objectively are omitted from the statement.

Question 20

What is the matching principle?

Answer 20

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

Question 21

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

Answer 21

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

Question 22

How is a discontinued operation reported on the income statement?

Answer 22

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

Question 23

Limitations of the income statement include

Answer 23

Items of income and expense may be omitted from the income statement and reported on the statement of other comprehensive income.
Financial statements report accrual-basis results for the period.
Preparing the income statement requires estimates and management judgment

Question 24

Define comprehensive income.

Answer 24

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 25

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

Answer 25

The effective portion of a gain or loss on a hedging instrument in a cash flow hedge
Unrealized holding gains and losses due to changes in the fair value of available for sale debt securities
Translation gains and losses for financial statements of foreign operations
Certain amounts associated with accounting for defined benefit postretirement plan

Question 26

What are the acceptable presentation formats of other comprehensive income?

Answer 26

Other comprehensive income may be presented in either
One continuous financial statement that has two sections or
Two separate but consecutive statements.

Question 27

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

Answer 27

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

Question 28

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

Answer 28

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

Question 29

How are changes in accounting estimates reported in financial statements?

Answer 29

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 30

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

Answer 30

Dr. Cash $XXX
Cr. Common stock $XXX
Cr. Additional paid-in capital $XXX

Question 31

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

Answer 31

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 32

How is a stock dividend accounted for?

Answer 32

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 33

How is a stock split accounted for?

Answer 33

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 34

Limitations of the statement of changes in equity include

Answer 34

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

Question 35

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

Answer 35

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 36

Define operating activities.

Answer 36

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 37

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

Answer 37

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

Question 38

Define investing activities.

Answer 38

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 39

Define financing activities.

Answer 39

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.