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Chapter 1
Financial Accounting
and Business Decisions
QUESTIONS
1. Accounting can be defined as the process of measuring the economic activity of an enterprise
in monetary terms and communicating the results to interested parties. The basic purpose of
accounting is to provide financial information that is useful in making economic decisions.
2. The major goal of Financial Accounting is the preparation of a balance sheet, a statement of
stockholders’ equity, a statement of cash flows, and an income statement for external users.
These statements must be prepared in accordance with a well-defined set of conventions
and rules called generally-accepted accounting principles. Managerial Accounting provides
the data necessary for management to plan and control the operations of a business and to
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approach or mode of accounting may be employed in this area.
3. In addition to stockholders and creditors, the following outside groups may be interested in a
company's financial data: prospective investors and creditors, financial analysts, taxing
agencies, regulatory agencies, labor unions, and economic planners. Prospective investors
and financial analysts desire to evaluate the relative attractiveness of various investments,
while creditors are primarily interested in a firm's financial strength. Taxing and regulatory
agencies are concerned with whether a firm has met its reporting or other legal requirements.
Labor unions are interested in the firm's relations with employees, especially with regard to
wages. Economic planners use reliable financial data in their planning and forecasting
activities.
4. Generally-accepted accounting principles (GAAP) are the standards, procedures and rules
that accountants follow when preparing financial statements. Many principles have evolved
over time and have become entrenched through general acceptance. Although the SEC has
the power to set the accounting principles, the agency has largely delegated that principle-
setting responsibility. The primary non-governmental body whose pronouncements are
authoritative concerning such principles is the Financial Accounting Standards Board
(FASB).
5. The main advantages of the corporate form of organization are limited liability afforded to
stockholders and the ease of selling ownership interests. The main disadvantage is the
double taxation of the corporation’s net income at both the company and individual levels.
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6. Financial accounting provides financial information to investors and creditors who need to
make decisions about where to allocate their resources. Financial statements express the
economic activity of business entities in money terms and report on the entities' profitability,
financial strength, and cash flow. Financial statements that present the results of economic
activity fairly and completely should contribute significantly to the best possible allocation
decisions by investors and creditors.
7. The accounting equation is Assets = Liabilities + Stockholders' Equity. Assets are the
economic resources owned by a business that can be expressed in monetary terms.
Liabilities are the obligations, or debts, that a business must pay in cash or in goods and
services at some future time as a consequence of past transactions or events. Stockholders'
equity is the ownership claims on the assets of the business and is represented as the
difference between the enterprise's assets and liabilities.
8. The three types of business activities are operating activities, investing activities, and
financing activities. Operating activities are the day-to-day business transactions of an
enterprise. Investing activities are those events in which the firm acquires long-term
resources necessary to conduct its business. And, financing activities consist of debt or
equity financing that generate the funds necessary to conduct its business.
9. Corporate social responsibility is a value system that believes that enterprises should focus
on more than just a business’ financial bottom line. Instead, the enterprise should also act
socially responsible and also focus on its environmental bottom line.
10. GAAP are the accounting standards, procedures and rules promulgated by the FASB to
assist companies in the U.S. toTprepare
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M IFRS are the accounting
guidelines promulgated by the IASB to guide international businesses in the preparation of
their financial statements.
11. Revenues are an increase to a company’s resources that result when it provides goods or
services to its customers. Sales revenue is measured by the value of the assets received in
exchange for the goods or services delivered. Expenses are the decreases in a company’s
resources from generating revenues. Expenses are measured by the value of the assets that
are used up or exchanged as a result of a firm’s operating activities.
12. The purpose of an income statement is to report the results of operations for a period. It does
this by listing a firm's revenues and expenses for the period. The purpose of a statement of
stockholders' equity is to report the events causing a change in stockholders' equity for a
period. These events include owner investments and dividends and the earning of net
income or net loss. The purpose of a balance sheet is to present a firm's assets, liabilities,
and stockholders' equity on a given date. The purpose of a statement of cash flows is to
report information about cash inflows and cash outflows during a period of time. The cash
flows are grouped into three categories: operating activities, investing activities, and financing
activities.
13. A period-in-time statement presents financial information covering a specific period of time.
These include the income statement, the statement of stockholders' equity, and the
statement of cash flows.
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14. A point-in-time statement presents financial information as of a specific date. An example is
a balance sheet.
15. $700,000 Assets - $220,000 Liabilities = $480,000 Stockholders' equity
(300,000) Common stock
$180,000 Retained earnings
16. The following three aspects of the accounting environment may create ethical pressure on
the accountant. (1) The output produced by accountants may have significant financial
implications for one or more persons. Examples include calculation of a bonus amount or of
income taxes owed. (2) Accountants have access to confidential, sensitive information, such
as salary data, income tax returns, and details of various financial arrangements. (3) U.S.
businesses tend to emphasize short-term profits, which may create pressure on accountants
if management engages in unethical procedures to influence profits in the short run.
17. The Management Discussion and Analysis (MD&A) section contain’s management’s
interpretation of the company’s recent performance and financial condition and may also
contain forward-looking statements about the company’s future opportunities and risks.
18. An auditor’s report provides assurance to financial statement users that the data in the
statements is fairly presented, and therefore, is likely to be useful for economic decision-
making purposes.
19. a. False. The accounting process involves both measuring and communicating economic
activities.
b. False. Potential users
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agencies, investors, creditors, among others.
c. True. Financial accounting is primarily used to communicate to outside users and
managerial accounting is primarily used for internal communication.
d. False. Because auditors are independent of the companies that they audit, their opinion
helps to provide assurance to financial statement users that the information is
fairly presented; however, they cannot guarantee that the financial statements
are without error.
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