Module 3 Notes

Which of the financial statements are required by the generally accepted accounting principles (GAAP)?

All of these financial statements are required by GAAP

Which of the following is normally shown first on the statement of cash flows?

Cash flow from operating activities

Which of the following transactions would be reported on the Statement of Changes in Stockholders' Equity?

Paid a $100 cash dividend to the owners Dividends are reported as a deduction from retained earnings on the Statement of Changes in Stockholders' Equity. The other transactions listed (borrowing cash from the bank, purchasing land for cash and Paying off a portion of a note payable) do not affect stockholders' equity.

What does negative retained earnings indicate?

The company has lost some or all of the owner's investment.

Chester Company earned $12,500 of cash revenue, paid $7,500 for cash expenses, and paid a $200 cash dividend to its owners. Which of the following statements is true?

The net cash inflow from operating activities was $5,000. Cash revenue and cash expenses are operating activities. Paying dividends is a financing activity. $12,500 revenue − $7,500 expense = $5,000 cash inflow from operating activities.

Which of the following are shown on the Balance Sheet? a)Total assets b)Land c)Common Stock d)Net Change in Cash e)Revenue f)Notes Payable g)Stockholders' Equity h)Total Liabilities and Stockholders' Equity i)Expenses j)Net Income k)Ending cash balance l)Beginning cash balance m)Dividends

a, b, c, f, g, h, k The Balance Sheet lists a company's Assets, Liabilities and Stockholders' Equity. From the information given, land, cash, total assets, common stock, notes payable, stockholders' equity, and total liabilities and stockholders' equity would be listed on the Balance Sheet.

The statement of changes in stockholders' equity presents...

an explanation of the changes in the beginning and ending balances of stockholders' equity.

At the time of liquidation, Owens Company reported assets of $260,000, liabilities of $180,000, common stock of $90,000 and retained earnings of ($10,000). What amount of Fairchild's assets are the shareholders entitled to receive?

$80,000 Creditors receive first priority in asset distribution during a business liquidation. Therefore, creditors would collect the $180,000 owed to them, leaving the shareholders with the remaining $80,000

At the beginning of Year 2, Jones Company had a balance in common stock of $200,000 and a balance of retained earnings of $5,000. During Year 2, the following transactions occurred: Issued common stock for $50,000 Earned net income of $30,000 Paid dividends of $10,000 Issued a note payable for $20,000 Based on the information provided, what is the total stockholders' equity on December 31, Year 2?

$275,000 The total stockholder's equity equals Ending Common Stock + Ending Retained Earnings. First, ending common stock is calculated as: beginning common stock + stock Issued or $200,000 + $50,000 = $250,000 ending common stock. Next, ending retained earnings is calculated as: beginning retained earnings + Net income - Dividends or $5,000 + $30,000 - $10,000 = $25,000 ending retained earnings. Finally, ending common stock of $250,000 + ending retained earnings of $25,000 = total stockholders' equity of $275,000. Paying back a portion of a note payable does not affect stockholders' equity and therefore it is not included in the calculation.

Which of the following financial statements is prepared as of a specific date?

Balance Sheet The Balance Sheet is prepared as of a specific date. The other three financial statements show what happened over a period.

Ending cash balance is shown on which of the following financial statements?

Balance Sheet and Statement of Cash Flows The ending cash balance is listed on the Statement of Cash Flows and Cash listed on the Balance Sheet is the balance as of the end of the year.

The stockholders of a business have a priority claim to its assets in the event of liquidation. This statement is:

False Creditors have priority over stockholders in the event of a company's liquidation.

What is the process of dividing up assets and allocating them to resource providers (creditors and investors)?

Liquidation

Durango Company started Year 2 with beginning balances of $1,000 cash, $500 note payable, and $400 common stock. During the year, Durango generated $400 of cash revenue and $300 of cash expenses. Durango also purchased land for $900 cash. If the note payable is due on January 1, Year 3, was it a good idea to purchase the land?

No, because the company will not have enough cash to pay off the note. Management has mismanaged the assets. On January 1, Year 3 there is not enough cash to pay off the note. There is $200 in cash and there is a $500 note due.

The Statement of Changes in Stockholders' Equity is measured for a period of time such as a year. This statement is:

True

A company can have a negative balance in retained earnings. This statement is:

True A company can have a positive or negative ending balance in retained earnings.

Which of the following are shown on the Income Statement? a)Total assets b)Land c)Common Stock d)Net Change in Cash e)Revenue f)Notes Payable g)Stockholders' Equity h)Total Liabilities and Stockholders' Equity i)Expenses j)Net Income k)Ending cash balance l)Beginning cash balance m)Dividends

e, i, j The Income Statement lists a company's Revenue, Expenses and Net Income for the period.

The statement of cash flows presents

information in three categories including operating, investing, and financial activities.

Watt Company was established in January, Year 1. During Year 1 the company experienced the following events. Collected $6,000 cash from the issue of common stock. Borrowed $3,000 cash from the state bank. Earned $4,000 of cash revenue. Paid $2,000 cash expenses. The company was liquidated at the end of Year 1. Based on this information

the stockholders would receive $8,000. The stockholders reap the reward of a profitable business and suffer the consequences of losses incurred. In this case the business earned $2,000 ($4,000 Revenue − $2,000 Expenses). As a result, the stockholders would receive $8,000 in the liquidation ($6,000 original investment + $2,000 retained earnings).

Emerald Company was established in January, Year 1. During Year 1 the company experienced the following events. Collected $50,000 cash from the issue of common stock Borrowed $45,000 cash from the state bank Earned $120,000 of cash revenue Paid $180,000 cash expenses The company was liquidated at the end of Year 1. Based on this information

the creditor (the bank) would receive $35,000. The stockholders reap the reward of a profitable business and suffer the consequences of losses incurred. In this case the business incurred a $60,000 loss ($120,000 Revenue − $180,000 Expenses). As a result, the stockholders would receive zero. The $60,000 loss would more than wipe out their $50,000 investment. Indeed, even the creditor would suffer a $10,000 loss. At the end of the Year 1 there would only be $35,000 cash left in the business ($50,000 from investors + $45,000 from the bank, $120,000 from revenue − $180,000 of expenses). While creditors have first priority in a business liquation, they cannot receive assets that the business does not have. In this case, even though the creditors put $45,000 in the business, they would only receive $35,000 back. While creditors get first claim on assets, they are still at risk of losing some or all of the assets loaned to a business. First claim increases security but it does not eliminate risk.

Kilgore Company experienced the following events during its first accounting period. (1) Issued common stock for $5,000 cash. (2) Earned $3,000 of cash revenue. (3) Paid a $4,000 cash to purchase land. (4) Paid cash dividends amounting to $400. (5) Paid $2,200 of cash expenses. Based on this information, the amount of cash flow from investing activities appearing on the statement of cash flows is

$4,000 outflow. Investing activities include the purchase or sale of long-term assets. The only transaction affecting investing activities is the purchase of land. Therefore, there was a $4,000 cash outflow for investing activities shown on the statement of cash flows for the purchase of land.

The following information was drawn from Gore, Inc.'s statement of cash flows. (1) $2,000 net cash outflow from investing activities. (2) $3,000 net cash inflow from financing activities. (3) $6,000 net increase in the cash balance. Based on this information, the amount of cash flow from operating activities appearing on the statement of cash flows must be a

$5,000 net cash inflow. Recall that the $6,000 increase in the cash balance is caused by financing, investing, and operating activities. Focus on how each of these activities changed the cash balance. The cash balance increased by $3,000 due to financing activities and decreased by $2,000 due to the investing activities. This explains $1,000 ($3,000 inflow - $2,000 outflow) of the $6,000 net increase in the cash balance. The remaining $5,000 ($6,000 - $1,000) of the total $6,000 increase must have been caused by a net increase in the cash flow from operating activities.

The Statement of Changes in Stockholders' Equity shows changes in which of the following accounts?

Common Stock and Retained Earnings Stockholders' equity is made up of two accounts: Common Stock and Retained Earnings. The Statement of Changes in Stockholders' Equity shows changes in those two accounts over the period.

A net loss occurs when

Expenses are greater than revenue

The Statement of Changes in Stockholders' Equity is used to inform the creditors how their stake in the company changed over the period. This statement is:

False The Statement of Changes in Stockholders' Equity is used to inform the investors (i.e. owners) how their stake in the company changed over the period. The creditors' claims to the company are reported in the liabilities section of the balance sheet.

How many financial statements does a company prepare each accounting period?

Four The Balance Sheet, Income Statement, Statement of Changes in Stockholders' Equity and the Statement of Cash Flows are prepared each accounting period.

Net income appears on which of the following financial statements?

Income Statement and Statement of Changes in Stockholders' Equity Net income is shown on the Income Statement. It is also shown as an addition to Retained Earnings on the Statement of Changes in Stockholders' Equity.

Which of the following is a financing activity?

Paying cash dividends Financing activities include cash flows that result from transactions between a business and its stockholders. Since dividends are paid to stockholders, the associated cash outflow is classified as resulting from financing activities.

The balance of accounts reported on the Balance Sheet carry forward from one period to the next. This statement is:

True The ending account balances for Year 1 become the beginning account balances for Year 2 for accounts on the Balance Sheet.