Quiz Chapter 1

Describe the primary forms of business organization.

A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock.

Explain the three principal types of business activity.

Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit

Retained earnings statement

How much of this year's income did the company pay out in dividends to shareholders? A company striving for rapid growth will pay a low (or no) dividend

Identify the users and uses of accounting information.

Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to help them decide whether to buy, hold, or sell shares of a company's stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies.

Statement of cash flows

The statement of cash flows shows the amount of cash provided or used by operating activities, investing activities, and financing activities. Compare the amount of cash provided by operating activities with the amount of cash used by investing activities. Any deficiency in cash from operating activities must be made up with cash from financing activities.

What should these financial statements tell you?

You would probably be most interested in the income statement because it tells about past performance and thus gives an indication of future performance. The retained earnings statement provides a record of the company's dividend history. The balance sheet reveals the relationship between assets and liabilities. The statement of cash flows reveals where the company is getting and spending its cash. This is especially important for a company that wants to grow.

Do you care if the financial statements have been audited? Explain.

You would want audited financial statements. These statements indicate that a CPA (certified public accountant) has examined and expressed an opinion that the statements present fairly the financial position and results of operations of the company. Investors and creditors should not make decisions without studying audited financial statements.

Describe the content and purpose of each of the financial statements.

An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders' equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time

Explain the meaning of assets, liabilities, and stockholders' equity, and state the basic accounting equation.

Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders' equity represents the claims of owners on the assets of the business. Stockholders' equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is .

What financial statements should you evaluate?

Before you invest, you should evaluate the income statement, retained earnings statement, balance sheet, and statement of cash flows.

Balance sheet

The balance sheet reports the company's resources and claims to those resources. There are two types of claims: liabilities and stockholders' equity. Compare the amount of debt versus the amount of stockholders' equity to determine whether the company relies more on creditors or owners for its financing.

Income statement

The income statement reports a company's revenue and expenses and resulting net income or loss for a period of time. If the company's revenue exceeds its expenses, it will report net income; otherwise, it will report a net loss.

Describe the components that supplement the financial statements in an annual report.

The management discussion and analysis provides management's interpretation of the company's results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor's report expresses an opinion as to whether the financial statements present fairly the company's results of operations and financial position.