Chapter 1
Financial Statements and Business Decisions
Revised: November 4, 2019
ANSWERS TO QUESTIONS
1. Accounting is a system that collects and processes (analyzes, measures, and records)
financial information about an organization and reports that information to decision
makers.
2. Financial accounting involves preparation of the basic financial statements and related
disclosures for external decision makers. Reporting is generally on a quarterly and annual
basis. Managerial accounting involves the preparation of detailed plans, budgets, forecasts,
and performance reports for internal decision makers. Reporting is on an ongoing basis.
3. Financial reports are used by both internal and external groups and individuals. The
internal users are the various managers of the entity, e.g. marketing, credit, and
purchasing. The external groups include the owners, investors, creditors, governmental
agencies, other interested parties, and the public at large.
4. Investors purchase all or part of a business and hope to gain by receiving part of what the
company earns and/or selling their share of the company in the future at a higher price
than they paid. Creditors lend money to a company for a specific length of time and hope
to gain by charging interest on the loan.
5. An accounting entity is the organization for which financial data are to be collected. Typical
accounting entities are a business, a church, a governmental unit, a university, and other
nonprofit organizations such as a hospital. A business is defined and treated as a separate
entity because the owners, creditors, investors, and other interested parties need to
evaluate its performance and its potential separately from other entities and from its
owners.
6. The heading of each of the four required financial statements should include the following:
(a) Name of the entity
(b) Title of the statement
(c) Specific date or period of the statement, or the period of time it covers
(d) Unit of measure
7. (a) The purpose of the statement of earnings is to present information about the
revenues, expenses, and the net earnings of the entity for a specified period of time,
in order to help assess its financial performance during that period.
, (b) The purpose of the statement of financial position is to report the financial position
of an entity at a given date, that is, to report information about the assets,
obligations, and shareholders’ equity of the entity as at a specific date.
(c) The purpose of the statement of cash flows is to present information about the flow
of cash into the entity (sources), the flow of cash out of the entity (uses), and the net
increase or decrease in cash during the period.
(d) The statement of changes in equity reports the way that net earnings, the
distribution of net earnings (dividends), and other changes to shareholders’ equity
affected the company’s financial position during the accounting period. The focus in
this chapter is on retained earnings. Net earnings for the year increases the balance
of retained earnings whereas the declaration of dividends to the shareholders
decreases retained earnings.
8. The statement of earnings and the statement of cash flows are dated “For the Year Ended
December 31, 2020” because they report the inflows and outflows of resources during a
period of time. In contrast, the statement of financial position is dated “At December 31,
2020” because it represents the resources, obligations, and shareholders’ equity as at a
specific date, December 31, 2020.
9. Assets are important to investors and creditors because assets provide a basis for judging
whether sufficient resources are available to operate the company. Liabilities are
important to creditors and investors because the company must be able to generate
sufficient cash from operations or further borrowing to meet the payments required by
debt agreements. If a business does not pay its creditors, the law may give the creditors
the right to force the sale of assets sufficient to meet their claims.
10. Net earnings is the excess of total revenues over total expenses. Net loss is the excess of
total expenses over total revenues.
11. The accounting equation for the statement of earnings is Revenues – Expenses = Net
earnings. Revenues result from the sale of goods and services to customers, regardless of
the timing of collection of cash from customers. Expenses represent the monetary value of
resources the entity used up, or consumed, to earn revenues during the period. Net
earnings is simply the excess of revenues over expenses.
12. The accounting equation for the statement of financial position is:
Assets = Liabilities + Shareholders’ Equity
Assets are the probable (expected) future economic benefits owned by the entity as a
result of past transactions. They are the resources owned by the business at a given point
in time such as cash, accounts receivable, merchandise inventory, machinery, buildings,
land, and patents. Liabilities are probable (expected) debts or obligations of the entity as a
result of past transactions that will be discharged with assets (usually, cash) or services in
the future. They are the obligations of the entity such as accounts payable, notes payable,
and bonds payable. Shareholders’ equity is financing provided by owners of the business
, and by the net earnings generated from the operations of the business. It is the claim of
the owners to the assets of the business after the creditor claims have been satisfied.
Shareholders’ equity may be thought of as the residual interest because it represents
assets minus liabilities.
13. The accounting equation for the statement of cash flows is: Cash flows from operating
activities +/– Cash flows from investing activities +/– Cash flows from financing activities =
Change in cash for the period. The net cash flows for the period represent the increase or
decrease in cash that occurred during the period. Cash flows from operating activities are
cash flows directly related to earning income (normal business activity including interest
paid and income taxes paid). Cash flows from investing activities comprise cash flows that
are directly related to the acquisition or sale of productive assets used by the company,
such as plant and equipment. Cash flows from financing activities consist of cash flows that
are directly related to the financing of the enterprise, such as issuing shares to investors.
14. The accounting equation for retained earnings is:
Beginning retained earnings + Net earnings – Dividends = Ending retained earnings
The equation begins with beginning-of-the-year retained earnings, i.e., the prior year’s
ending retained earnings reported on the statement of financial position. The current
year's net earnings reported on the statement of earnings is added to this amount and the
dividends declared during the current year are subtracted from this amount. The ending
retained earnings amount is reported on the end-of-period statement of financial position.
15. Credit managers use customers' financial statements to decide whether to extend them
credit for their purchases. Purchasing managers use potential suppliers' financial
statements to judge whether the suppliers have the resources necessary to meet current
and future demand. Human resource managers use the financial statements as a basis for
contract negotiations to determine, for example, what pay rates the company can afford.
The net earnings figure can also serve as a basis to pay bonuses not only to management,
but to other employees through profit sharing plans.
16. In Canada, provincial securities legislation created securities commissions, most notably
the Ontario Securities Commission (OSC), to regulate Canadian capital markets and the
flow of financial information provided by publicly traded companies whose shares trade on
Canadian stock exchanges, such as the Toronto Stock Exchange. Similar to the SEC, the OSC
plays an influential role in promoting sound accounting practices by publicly traded
companies. Since their establishment, these securities commissions have worked with
organizations of professional accountants to establish groups that are given the primary
responsibilities to work out the detailed rules that Canadian entities must use. The name of
the current Canadian group that has this responsibility is the Accounting Standards Board
(AcSB). The AcSB is responsible for establishing standards of accounting and reporting by
Canadian companies and not-for-profit organizations.
, 17. The officers of the company, usually the CEO and the CFO, must personally sign a
certification that they have designed or supervised the design, implementation, and
evaluation of effective, appropriate financial accounting and reporting processes. The
executives and officers of the company bear primary responsibility for information
prepared and reported in the financial statements and other information contained in the
annual report. Top management also nominates members to the Board of Directors to
oversee the integrity of the first two safeguards. Those owning shares of the firm vote to
elect the Board of Directors, which holds the officers of the company accountable to the
shareholders for defects in the internal control and reporting system. It also appoints
external, independent auditors who provide advice to companies on how to best comply
with regulations on financial reporting.
18. A sole proprietorship is an unincorporated business owned by one individual. A partnership
is an unincorporated association of two or more individuals to carry on a business. A
corporation is a business that is organized under federal or provincial laws, whereby a
charter is granted and the entity is thus authorized to issue shares as evidence of
ownership by the owners (i.e., shareholders). Corporations are legal entities separate from
their owners, but sole proprietorships and partnerships are not.
19. Public practice accounting firms normally render three types of service: assurance services,
management advisory services, and tax services. Assurance services, including auditing,
involves examination of the records and financial statements to determine whether they
“fairly present” the financial position and results of operations of the entity in accordance
with the applicable accounting standards. Management advisory (consulting) services
include providing expert business advice to management. Tax services involve providing
tax-planning advice to clients (both individuals and businesses) and preparation of their tax
returns.
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller premiumbiz379. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $33.41. You're not tied to anything after your purchase.
