Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 1 CHAPTER 1 Introduction to Financial Statements Learning Objectives 1. Identify the forms of business organization and the uses of accounting information. 2. Explain the three principal types of business activity. 3. Describe the four financial statements and how they are prepared . *4. Explain the career opportunities in accounting. ANSWERS TO QUESTIONS 1. The three basic forms of business organizations are (1) sole proprietorship, (2) partnership, and (3) corporation. LO 1 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective 2. Advantages of a corporation are limited liability (stockholders not being personally liable for cor -
porate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a corporation are increased taxation and government regulations. LO 1 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective 3. Proprietorships and partnerships receive favorable tax treatment compared to corporations and are easier to form than corporations. They are also owner controlled. Disadvantages of proprietorships and partnerships are unlimited liability (proprietors/partn ers are personally liable for all debts) and difficulty in obtaining financing compared to corporations. LO 1 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective 4. Yes. Companies can choose one of the hybrid business forms, limited liability corporations (LLCs) or subchapter S corporations, which combine the tax advantages of partnerships with the limited liability of corporations. LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective 5. Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Accounting provides financial information to interested users through the preparation and distribution of financial statements. LO 1 BT: C Difficulty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 6. Internal users are managers who plan, organize, and run a business. To assist management, accounting provides timely internal reports. Examples include financial comparisons of operating 2 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) alternatives, projections of income from new sales campaigns, forecasts of cash needs for the next year, and financial statements. LO 1 BT: C Difficulty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 7. External users are those outside the business who have either a present or potential direct financial interest (investors and creditors) or an indirect financial interest (taxing author ities, regu -
latory agencies, labor unions, customers, and economic planners). LO 1 BT: C Difficulty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 8. The four most common types of data analytics and the basic question each addresses are: Descri ptive (What happened?), Diagnostic (Why did it happen?), Predictive (What is likely to happen?), and Prescriptive (What should we do about it?). LO 1 BT: K Difficulty: E TOT: 2 min. AACSB: nowledge AICPA AC: Measurement Analysis and Interpretation Questions Chapter 1 (Continued) 9. The three types of business activities are financing activities, investing activities, and operating activities. Financing activities include borrowing money and selling shares of stock. Investing activities include th e purchase and sale of property, plant, and equipment. Operating activities include selling goods , performing services, and purchasing inventory. LO 2 BT: C Difficulty : M TOT: 2 min. AACSB: Knowledge AICPA AC: Reporting 10. (a) Income statement. (d) Balance sheet. (b) Balance sheet. (e) Balance sheet. (c) Income statement. (f) Balance sheet. LO 3 BT: K Diff iculty : M TOT: 2 min. AACSB: Knowledge AICPA AC: Reporting 11. When a company pays dividends, it reduces the amount of assets available to pay creditors. Therefore, banks and other creditors monitor dividend payments to ensure they do not put a company’s ability to make debt payments at risk. LO 3 BT: C Difficulty : M TOT: 2 min. AACSB: Knowledge AICPA AC: Measurement Anallysis and Interpretation 12. Yes. Net income does appear on the income statement —it is the result of subtracting expenses from revenues. In addition, net income appears in the retained earnings statement —it is shown as an addition to the beginning -of-period retained earnings. Indirectly, the net income of a company is also included in the balance sheet. It is included in the retained earnings account which appears in the stockholders’ equity sec tion of the balance sheet. LO 3 BT: C Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 13. The primary purpose of the statement of cash flows is to provide financial information about the cash receipts and cash payments of a business f or a specific period of time. LO 3 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 3 14. The three categories of the statement of cash flows are operating activities, investing activities, and financing activities. The categories were chosen because they represent the three principal types of business activities. LO 3 BT: C Difficulty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 15. Retained earnings is the net income retained in a corporation. Retained earnings is i ncreased by net income and is decreased by dividends and a net loss. LO 3 BT: C Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 16. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity. LO 3 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 17. (a) Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put more simply, liabilities are existing debts and obligations. Stockholders’ equity is the ownership claim on net assets. (b) The items that affect stockholders’ equity are issuance of common stock and the components of retained earnings (dividends, revenues, and expenses ). LO 3 BT: K Diff iculty : E TOT: 2 min. AACSB: Knowledge AICPA AC: Reporting 18. The liabilities are (b) Accounts payable and (g) Salaries and wages payable. LO 3 BT: C Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 19. (a) Net income from the income st atement is reported as an increase to retained earnings on the retained earnings statement. (b) The ending amount on the retained earnings statement is reported as the retained earnings amount on the balance sheet. (c) The ending amount on the statemen t of cash flows is reported as the cash amount on the balance sheet. LO 3 BT: C Diff iculty : M TOT: 2 min. AACSB: Knowledge AICPA AC: Reporting 20. The purpose of the management discussion and analysis section is to provide management’s views on its ability to pay short -term obligations, its ability to fund operations and expansion, and its results of operations. The MD&A section is a required part of the annual report. LO 3 BT: K Diff iculty : E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting 21. An unqualified opinion shows that, in the opinion of an independent auditor, the financial state -
ments have been presented fairly, in conformity with generally accepted accounting principles. This gives investors more confidence that they can rely on t he figures reported in the financial statements. LO 3 BT: C Diff iculty : E TOT: 2 min. AACSB: Knowledge AICPA AC: Reporting 4 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 22. Information included in the notes to the financial statements clarifies information presented in the financial statements and includes descriptions of accounting policies, explanations of uncertain -
ties and contingencies, and statistics and details too voluminous to be reported in the financial statements. LO 3 BT: K Diff iculty : E TOT: 1 min. AACSB: None AICPA FC: Reporting 23. Using dollar amounts, Apple’s accounting equation (in millions) is: Assets = Liabilities + Stockholders’ Equity $323,,888 $258,549 $65,339 LO 3 BT: AP Diff iculty : E TOT: 2 min. AACSB: Analytic AICPA AC: Reporting Questions Chapter 1 (Continued) 24. A critical audit matter is an audit issue that was material in size a nd that involved challenging, subjective, or complex auditor judgement. LO 3 BT: K Difficulty: E TOT: 2 min. AACSB: Knowledge AICPA AC: Research SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1.1 (a) P Shared control, tax advantages, increased skills and resources. (b) SP Simple to set up and maintains control with owner. (c) C Easier to transfer ownership and raise funds, no person al liability. LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: Knowledge AICPA BC: Governance Perspective BRIEF EXERCISE 1.2 (a) 4 Investors in common stock (b) 3 Marketing managers (c) 2 Creditors (d) 5 Chief Financial Officer (e) 1 Internal Revenue Service LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: Knowledge AICPA AC: Measurement Analysis and Interpretation
