Ch. 2 Basic Financial Statements

long-term investments in securities are recorded on the balance sheet at their original cost, unless the market value has increased significantly, in which case they should be written up to their fair market value T/F

False

Dividends are distributions of profits to the owner's of a corporation, and therefore represent an expense to the firm T/F

False

The capital stock account combined with the retained earnings account reflect the valuation the open market places on the company T/F

False

The collection of an account receivable generates cash, which implies an increase in assets T/F

False

current assets are properly listed in order of liquidity on a balance sheet as shown in the following example: cash, accounts receivable, prepaid insurance, inventory T/F

False

prepaid items have already been converted to cash and therefore are the most liquid items in the current assets portion of the balance sheet T/F

False

An asset is only a tangible, economic resource of a firm that can be measured in monetary terms T/F

False; Assets need not be tangible, as long as they are measurable in monetary terms. An example of an intangible asset is a patent

the balance maintained in a checking account (also called a demand deposit or DDA account) is considered a part of a company's cash account T/F

True

examples of assets

accounts receivable, prepaid insurance, cash, inventory, plant & equipment, investment, office supplies, prepaid expenses, accrued interest receivable

two dominating financial statements

balance sheet and income statement (the retained earnings statement is also required)

examples of liabilities

bonds payable, accounts payable,

assets are listed on the balance sheet in order of liquidity

cash, certificate of deposit, accounts receivable, inventory, prepaid insurance, building, land

expenses

cost of good sold, operating expenses, interest, and taxes

given today's importance of cash control,, cash method accounting is preferred in most sophisticated organizations T/F

false

retained earnings are the earnings that a company saves and reinvests; they can be used whenever the company needs cash t/f

false' retained earnings is the total net income of a company since it was incorporated, less any dividends paid over that time. In accrual-based accounting, net income is not in the form of cash, this neither is retained earnings. It is wrong to think of retained earnings as a pool of funds which are available to the corporate treasurer, because retained earnings are nothing more than the accumulated successes of the enterprise which have not been distributed as dividends

Dividends can be paid to stockholders only following a year in which a company has generated net income T/F

false; a company can pay dividends any time its board of directors so chooses, whether the firm has operated profitably or at a net loss for the year. The only restriction placed on dividend declarations is that retained earnings cannot become negative in order to pay the dividend. In addition, because dividends are discretionary, not contractual, uses of cash, it is generally not advisable to pay a dividend if the payment will severely strain the cash position of the company

the money spent to buy equipment is called an expense T/F

false; money spent to buy equipment is called capital expenditure. The historical cost of the equipment is reported on the balance sheet under the category property, plant and equipment. Such purchases are said to be capitalized because they are set up as assets rather than flowing directly through to the income statement. Each year a portion of the cost of equipment is charged against income in the form of depreciation expense

a company's property holdings are usually listed at fair market value on the balance sheet T/F

false; property like any asset is carried on a company's books and is listed on its balance sheet at its original purchase price. This is known as the historical cost or acquisition cost of the asset. Only in those instances where an asset's value has shown material decline in value from it acquisition cost is it proper to adjust the asset value. This is another example of the conservatism principle at work in accounting

current assets almost always equal current liabilities t/f

false; the resources of an organization are composed of current and noncurrent assets. The claims on those assets are current and noncurrent liabilities, as well as the equity of the owners. In total, assets must equal liabilities plus equity; however, the components of each side of the equality need not be equal since an increase in current assets could be financed by an increase in current liabilities, noncurrent liabilities or owners' equity. Because current assets and current liabilities are independent, they need not be equal

the statement of retained earnings shows the revenues, expenses, and net income of an enterprise over a period of time T/F

false; the statement of retained earnings shows the retained earnings at the beginning of the period, plus net income, less dividends. Finally the ending retained earnings are shown

Income statement

focuses on the static position of the company at a point in time. Reports the results of operations for a firm for a short period of time. "how well the firm has performed"; prepared on an accrual basis

retained earnings

includes sales, cost of goods sold, salaries and interest expense

Total Assets = Total Liabilities + Owners' Equity

more complex: (current assets + plant & equipment) = (current liabilities + long-term liabilities) + owners' equity

long term liabilities example

notes payable, mortgage payable

retained earnings

reports the increases in accumulated, undistributed income from the time of incorporation, plus current earnings, less current dividends

owners' equity examples

retained earnings and capital stock

accrual basis

revenues are recognized when earned not received and expenses recognized when incurred not paid

examples of owners' equity

salaries expense, capital stock, cost of goods sold, retained earnings, interest expense, sales

Assets=liabilities + owner's equity

the basis for double entry bookkeeping; an increase in assets must be balanced by an equal and offsetting increase in liabilities or equity or decrease in other assets

balance sheet

the snapshot of the business. reports the financial position of an enterprise at a point in time. Any increase in assets, liabilities, or equity would flow through to the balance sheet

Liabilities =assets - owner's equity T/F

true; assets = liabilities + owner's equity or liabilities = assets - owner's equity or owner's equity = assets - liabilities

which of the following is a liability (a) accounts payable, (b) inventory, (c) investments, (d) prepaid insurance, (e) none of the above

(a) accounts payable; a liability is an economic obligation of a firm. The only such obligation among the choices is accounts payable, which represents the total unsecured promises to pay for goods or services already received. Inventory, investments, and prepaid insurance are all economic resources of a firm, and are thus classified as assets

Which of the following accounts represents the original investment of the shareholders? (a) capital stock, (b) retained earnings, (c) liabilities, (d) assets, (e) none of the above

(a) capital stock

Goober Pyle purchased machinery for his auto shop at a cost of $5,000 with a note from the bank. Accordingly (a)liabilities increased $5K and assets increased $5K, (b) liabilities increased $5K and owners' equity decreased $5K,(c) assets and owners' equity both increased $5K, (d) none of the above

(a) liabilities and assets increased $5K; purchasing equipment with a note increases equipment (an asset) and notes payable (a liability) by $5K each

The retained earnings account is a part of which of the following accounts (a) owners' equity, (b) liabilities, (c) capital stock, (d) long-term assets, (e) none of the above

(a) owners' equity

The financial position at the end of a period is reflected on the (a) income statement, (b) balance sheet, (c) statement of retained earnings, (d) none of the above

(b) balance sheet

which of the following accounts is listed in order of reverse liquidity (a) current assets, (b) current liabilities, (c) both A & B, (d) long-term liabilities, (e) none of the above

(b) current liabilities

which of the following statements shows the dividends paid during the accounting period? (a) statement of financial position, (b) statement of retained earnings, (c)income statement, (d) B & C

(b) statement of retained earnings; The statement of financial position is the balance sheet. The income statement shows revenues and expenses for the period. The statement of retained earnings shows the beginning and ending retained earnings plus net income and dividends

A corporation's fiscal year does not always coincide with the calendar year. The most common reason for this disparity is (a) that most corporations don't begin operations on 1 JAN, (b) that the SEC assigns fiscal years for public corporations, (c) to favorably present the results of operations of seasonable enterprises

(c) The fiscal year of a corporation is chosen by its management or board of directors for any number of reasons, the most common being (1) tax considerations, (2) that in highly seasonal businesses, the date on which a balance sheet is presented should reflect favorably upon the selling cycle of the company, or at least be representative of the typical state of affairs of the company. A retailer, for example with heavy christmas sales would normally select a fiscal year ending after its inventory had been sold and the receivables converted to select a fiscal year ending after its inventory had been sold and the receivables converted to cash. The SEC expresses no opinion with respect to fiscal years. In start-up situations, a company can issue a "short" first year to close its books on the day of its chosen fiscal year end

Current assets are a firm's resources that are expected to be converted into cash within a year. The basis of this rule is (a) the matching principle, (b) the going concern principle, (c) accounting convention, (d) the monetary concept

(c) accounting convention; Accounting convention dictates the categories on the balance sheet. This idea of cash conversion within a year is an accounting convention, not a generally accepted accounting principle like A, B or D

one purpose of the statement of retained earnings is to show (a) how well a company performed in the previous year, (b) the financial position of a company at a point in time, (c) distribution of earnings to the stockholders, (d) claims on the company' resources, (e) none of the above

(c) distribution of earnings to the stockholders

Arial Corporation incorporated on January 1, 2012. The capital stock account at that time was $100K. Losses for 2012, 2013, and 2014 totaled $60K. The retained earnings account at the end of 2014 was (a)$40K, (b) $160K, (c) $60K, (d) -$60K

(d) -$60; the retained earnings account at the end of a period is the cumulative retained earnings from the day the corporation begins. In this case, losses for three years amounts to $60K in retained earnings

the retained earnings account could take the form of (a) accounts receivable, (b) inventory, (c) plant and equipment, (d) A,B & C

(d) A, B, & C; retained earnings concept is sometimes difficult to grasp. As a company generates earnings, these earnings can take the form of investments by the company. These investments can be in the form of accounts receivable, inventory, and plant and equipment

The cash account includes (a) cash on hand, (b) checks on hand that have been deposited, (c) cash in the bank, (d) all of the above

(d) all of the above

Which of the following is a liability (a)cash, (b) accounts receivable, (c) inventory, (d) none of the above

(d) none of the above

Which of the following statements represents a flow concept (a) balance sheet, (b) statement of retained earnings, (c) inventory statement, (d) none of the above

(d) none of the above

investments representing short-term holding of securities would appear on the balance sheet as (a) long-term liabilities, (b) long-term assets, (c) current assets, (d) current liabilities, (e) none of the above

(d) none of the above

which of the following is an asset (a) salaries payable, (b) taxes payable, (c) accounts payable, (d) none of the above

(d) none of the above

owner's equity can also be shown on the balance sheet as (a) net worth, (b) net assets, (c) stockholders' equity, (d) A & B, (e) A, B, & C

(e) A, B, and C; owners' equity represents the residual claim of the owners of a firm against the assets of the firm; that is, after creditors have made their claim to the assets they have financed, what remains for the equity holders? Net worth, net assets, and stockholders' equity are all descriptive of the same thing.

the operating expenses shown on an income statement usually include (a) cost of goods sold, (b) salaries, (c) administration, (d) A & B, (e) B & C

(e) B & C; salaries and administration expenses are usually shown on the income statement as operating expenses. Cost of goods sold is usually classified as a distinct item on an income statement and is traditionally displayed immediately after sales revenue in the report. It is normally not shown with the other expenses of operating a business, like salaries or administration

Which of the following represents the market valuation of the company (a) assets, (b) liabilities, (c) net assets, (d) retained earnings, (e) none of the above

(e) none of the above

which of the following is a snapshot of the financial position of the company (a) income statement, (b) statement of retained earnings, (c) cash flow statement, (d) inventory statement, (e) none of the above

(e) none of the above (this is the balance sheet)

You receive payment from a debtor. Which increases and decreases in Assets = Liabilities + Owners' Equity

Assets both increase and decrease.This is a simultaneous increase and decrease in assets - you are receiving cash and at the same time you are surrendering your account receivable

You make a cash settlement of an account payable. Which increase/decrease? Assets = Liabilities + Owner's Equity

Assets decrease, Liabilities decrease

A dividend is declared and paid in cash. Which increase decrease in Assets = Liabilities + Owner's Equity

Assets decrease, Owner's equity decreases

You sell 100 shares of common stock to Mr. Berry. Which increase and which decreases in Assets = Liabilities + Owner's Equity

Assets increase and Owner's equity increases

You purchase supplies on account which increases and decreases in Assets = Liabilities + Owner's Equity

Assets increase and liabilities increase. If this was purchased with cash and not on an account assets would have increased and decreased

You get a loan at a local bank. Which increase decrease in Assets = Liabilities + Owner's Equity

Assets increase, Liabilities increase

Amortization would be used to allocate costs over the useful life of which of the following (a) long-term assets, (b) long-term liabilities, (c) patent, (d) goodwill, (e) both C & D

C & D

Capital stock represents the market's value of the company T/F

False

dividends are one of the largest expenses that a corporation incurs T/F

False; Dividends are not an expense of the corporation. The corporation is not required to pay dividends. Dividends are viewed as a return to the stockholder for the investment made in the corporation, From a stockholder's perspective, returns can be gotten through stock appreciation and dividends

The statement of financial position (balance sheet) shows how well a company has performed over a period of time T/F

False; The balance sheet lists a company's assets, liabilities, and owner's equity. While it is possible to gather a general idea about the financial performance of a company from the statement of financial position it is difficult to tell over what time period this took place. The income statement is used explicitly for this purpose

Allison Corporation had net income of $18,000 for 2014. At the end of 2014, Allison paid out $10K in dividends. This payment left Allison with $8K cash in retained earnings, T/F

False; the payment left Allison with $8K in retained earnings, not necessarily cash. The retained earnings could take the form of inventory, accounts receivable and PP&E

the statement of retained earnings shows the revenues, expenses, and net income of an enterprise over a period of time T/F

False; the statement of retained earnings lists the beginning balance in retained earnings, to which net income for the period is added, and dividends paid during the same time period are deducted. The income statement discloses the revenues, expenses and net income of a firm over a period of time

current liabilities

Includes income tax payable, interest payable, wages payable, accrued rent payable, accrued salaries, trade payables

Arrow Inc was incorporated in 1904. Land was purchased at that time for $10K. This same land would be carried on the balance sheet of Arrow Inc in 2004 as $10K T/F

True

For accounting purposes, depreciation is an expense allocation scheme T/F

True

depreciation can be considered an allocated cost of using an asset with a life more than one year T/F

true; depreciation is a process of systematically and rationally allocating the cost of an asset over its useful life. It is a good example of the matching principle, in which expenses are recognized in the periods that they will provide benefit to the firm

stockholders' equity is the same as owners' equity T/F

true; in a corporation, stockholders are the owners of the firm; thus, the terms stockholders' equity and owners' equity are synonymous. Other forms of business enterprises include proprietorship and partnerships. Because a proprietorship is owned entirely by a single individual, the owners' equity is also called proprietors' capital. A partnership is a business owned jointly by two or more individuals with the goal of making a profit, and the equity in a partnership is often called partner's capital

liabilities are the claims of creditors to a company's resources T/F

true; liabilities are the debts or obligations of an enterprise. A company's resources (assets) can be funded through debt or equity or a combination of the two. Liabilities can be long term, like bonds payable or a mortgage payable, or they can be current in nature, like accrued wages or accounts payable

the "net worth" of a firm is shown on the company's balance sheet t/f

true; the term net worth is synonymous with owners' equity; thus it is reported on a company's balance sheet. In contemporary accounting parlance, equity is the preferred title. Net worth is considered an outdated title, although it is still frequently seen

one application of the conservatism principle is that inventory is values on the balance sheet at either its original cost or market value whichever is lower t/f

true; this practice is known as valuing inventories at the lower of cost or market (LCM). The concept of conservatism states that financial statements should provide for all probable losses and liabilities, provided that they can be measured with some degree of confidence. Conversely, income which is the result of an increase in the value of assets should not be recognized until a transaction has occurred, such as the sale of the underlying assets