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business
understanding financial accounting

Questions and Answers of Understanding Financial Accounting

Suppose a manager is choosing between debt and equity as a means for financing a large investment. Describe the financial statement effects of these two forms of financing and/or any associated
From what three sources do a company’s assets come? Define each source, and explain how the right side of the balance sheet provides a summary of them.
What asset accounts are usually considered to be current? Why is the current description helpful to users?
What is a prepaid expense and what liability account represents the reverse of a prepaid expense? Do these accounts represent cash inflows and outflows, respectively?
What is a revenue? How are revenues related to assets, liabilities, and retained earnings? What is a “core” revenue, and why are users interested in “core” revenues?
What is an expense? How are expenses related to assets, liabilities, and retained earnings? What is a “core” expense, and why are users interested in “core” expenses?
Retained Earnings is an account that appears in the stockholders’ equity section of the balance sheet, yet it consists primarily of revenues and expenses, which are both found on the income
What two statements explain the changes in balance sheet accounts during a period of time? How are the formats of these two statements similar?
The statement of cash flows is divided into three different categories. Name them and describe what transactions are contained within them.
Are all balance sheet accounts valued in the same way? Provide several examples.
What is the difference between short-term investments, listed in the asset section of the balance sheet, and capital stock, which can be found in the contributed capital portion of the balance sheet?
What income statement account is closely related to plant and equipment on the balance sheet?
What two asset accounts are closely related to the income statement account Sales? Can you name a liability account that relates to Sales? Go down the income statement and relate each income
“Net cash flow from operating activities” is listed on the statement of cash flows. This number is similar to, yet different from, net income, which appears on the income state¬ ment. Explain
What specific accounts and numbers on the financial statements would be particularly useful in assessing a company’s solvency position and earning power? Why?
How are the numbers in the financial statements used to control the business decisions of managers? Why is this necessary?
Suppose you are a manager who has signed a debt contract (covenant) requiring that the current ratio (current assets divided by current liabilities) be kept above 2:1. How might this affect the
Explain how cultural and environmental differences across countries make it difficult for investors and creditors who use financial statement information to make decisions.
Listed below are eight transactions. In each case identify whether the transaction is an exam¬ ple of financing, investing, or operating activities, and which of the financial statements it would
E2-3 (Balance sheet or income statement account?) Listed below are accounts that may appear on either the balance sheet or the income statement.a. Equipment j- Prepaid Expenseb. Fees Earned k. Gain
E2-4 (Relationships between retained earnings and revenues and expenses across time) Berne Incorporated, began operations in 1994. At the end of 1996 the company had a balance in its retained
E2-5 (Relationships between retained earnings and revenues and expenses across time) Merrytown Services began operations in 1994. At the end of 1996 the company had a balance in its retained earnings
E2-6 (The statement of cash flows across time) Miller and Company began operations on January 1, 1994. As of the end of 1996 Miller had a cash balance of $5,000. Compute the missing amounts in the
Technic began operations on January 1, 1992. As of the end of 1996 Technic had a cash bal¬ ance of $10,000. Compute the missing amounts in the following table. Describe and evaluate the company’s
E2-8 (Using working capital to assess solvency) A retail company’s recent balance sheets showed the following information. Accounts payable is the only current liability. 12/31/96 12/31/95 Cash $
E2-9 (The effects of different forms offinancing on financial statement numbers and debt covenants) Suppose the retail company in E2-8 signed a debt covenant specifying that current assets must be
E2-1Q (Using working capital to assess solvency) A manufacturing company’s recent balance sheets showed the following information. Accounts payable is the only current liability. 12/31/96 12/31/95
Suppose the manufacturing company in E2-10 signed a debt covenant specifying that current assets must exceed current liabilities by $12,000. Assume further that in early January of 1997 the company
E2-12 (Preparing a statement of cash flows) From the following transactions prepare a statement of cash flows for Lana and Sons in the proper form. The company began the year with a cash balance of
From the following transactions prepare a statement of cash flows for Emory Inc. in the prop¬ er form. The company began the year with a cash balance of $25,000. Describe and evaluate the
George began a business. After collecting $6,000 from an equity investor and borrowing $5,000 from a bank, he purchased a piece of land for $8,000. During the year he leased the land to Sheila and
E2—1 5 (Preparing financial statementsfrom simple transactions) Mary began a business. After collecting $30,000 from an equity investor and borrowing $15,000 from a bank, she purchased a piece of
Excerpts from the financial statements of Jones and Williams are provided on the next page. REQUIRED: Review this information, calculate any ratios that you believe may be useful in assessing this
Excerpts from the financial statements of Waters and Wheel are provided below. 1997 1996 Balance Sheet Current assets $20,000 $22,000 Long-term assets 43,000 45,000 Current liabilities 15,000 15,000
Presented below are the main section headings of the balance sheet:a. Current assetse. Current liabilitiesb. Long-term investmentsf. Long-term liabilitiesc. Property, plant and equipment g-
Presented below are the main section headings of the income statement:a. Sales ^b. Fees earned ec. Other revenues f REQUIRED: Classify the following descriptions under the appropriate headings and
The following information is available relating to the activities of Johnson Co. as of Decem¬ ber 31, 1996. Cash balance on 12/31/96 is $8,000. Short-term investments with a fair market value on
Compute the missing values for the chart below and analyze the financial performance position of this company. The first year of operations is 1993. (Balance sheet and income statement 1 996 1995 1
P2-5 (Using financial statements to assess solvency and earning power) Excerpts from the financial statements for Spartan Unlimited are provided below. The first year of operations was 1995. 1997
P2-6 (Analyzing financial statements) The chief executive officer of Romney Heights has included the following information from the financial statements in a loan application submitted to Acme Bank.
P2-7 (Analyzing financial statements) Ted Tooney has operated a small service company for several years. The following informa¬ tion is from the financial statements prepared by Ted’s accountant.
P2-8 (Balance sheet value and the fair market values ofthe assets) Because of consistent losses in the past several years, Eat and Run, a fast-food franchise, is in danger of bankruptcy. Its most
P2-9 A summary of the December 31, 1996, balance sheet of Ellington Industries follows: (Debt covenants can limit investments and dividends) Assets Current assets Land investments Total assets 1996
The following excerpt was taken from a recent financial report of Cummins Engine Company, a manufacturer of heavy-duty truck engines. Loan agreements contain covenants which impose restrictions on
C2-2 (Negative cashflows, positive net income, and dividends) For over a year, Center Energy Corporation, a utility company in Ohio, had negative cash flow from operating activities caused primarily
C2-3 (Debt covenant restrictions and the financial statements) Condensed statements of income and balance sheets for Deere & Co. are provided below (in millions) Statement of Consolidated Income 1
The Wall Street Journal (June 12, 1995) reported that Westinghouse reached an agreement to sell all of its real estate operations for about $550 million, which is estimated to be approxi¬ mately
Review the annual report of MCI and answer the following questions.a. Compute current assets, total communications systems (net), current liabilities, long-term debt, and stockholders’ equity as a
Define the accounting process, and briefly explain how it is a dynamic phenomenon.
What is a user orientation, what is an economic perspective, and why must astute man¬ agers adopt both? Provide several examples of each.
Capital providers include both equity and debt investors. Purchasing 100 shares of IBM common stock is an example of an equity investment. Bank loans and extensions of credit represent debt
Financial accounting statements are used by many parties. Describe how each of the par¬ ties listed below might use them.a. Security analysts and stockbrokersb. Bank loan officersc. A company’s
What does it mean to be solvent? What kind of financial information would be useful in assessing solvency? Would debt or equity investors be more likely to take a greater inter¬ est in assessing a
W.T. Grant, a large department store chain, reported profits on its income statement almost all the way up to its financial collapse. How could this happen? What kind of information could have
What is the purpose of the audit and the auditor’s report? What benefits do audits pro¬ vide for managers and investors? Under what conditions might managers choose not to have audited financial
What is meant by independent when describing auditors? Why is it important that they be independent? What incentives do they have to be independent? Are there pressures on auditors not to be
A major accounting firm commissioned an extensive poll to find out how people under¬ stand various business terms. According to the study, 34 percent of the shareholders ques¬ tioned thought that
Recently, a major accounting firm conducted and published an extensive survey on ethics in American business. The results indicate that intense concentration on short-term prof¬ its is a major
The same study referred to in Question 10 also discovered that ethical standards are per¬ ceived by business people to strengthen a company’s competitive position. Briefly explain how this could
Consider the following scenario. Tony Howard, a CPA, has completed the audit of Galaxy Enterprise and has signed an opinion letter stating that Galaxy’s books have been prepared “in conformance
A number of recent articles in publications like The Wall Street Journal, Forbes, and Time have noted that auditors are facing increasing levels of legal liability. At the same time, some business
We have stated that financial statements must contain objective and verifiable numbers if they are to be useful. Yet, we have also pointed out that many estimates and subjective assumptions are
What incentives might managers have to manipulate the numbers on the financial state¬ ments by choosing various estimates, assumptions, and accounting methods? Are gener¬ ally accepted accounting
This chapter mentioned that investors require managers to provide financial information so that they can (1) assess the levels of risk and potential returns offered by alternative investments and (2)
Why might an equity investor insist that a manager be paid a bonus expressed as a per¬ centage of income? Suppose that Elmer Smith is a manager of a company in its first year of operations who will
Why would a debt investor (e.g., a bank) insist on a loan contract specifying that total liabilities divided by total assets cannot exceed a certain percentage or that dividends paid to stockholders
According to generally accepted accounting principles, many of the assets on the bal¬ ance sheet are valued at historical cost: the cost incurred when the assets were originally purchased.a. How
In preparing financial statements to accompany a loan application for a local bank, Mary Jones was unsure about the proper reporting of a piece of land purchased by the company ten years ago. The
The AICPA’s list of red flags, alerting auditors to possible management fraud, includes “a domineering management coupled with a weak board of directors.” Briefly explain the role of the board
What government agency was formed shortly after the Great Depression to regulate the flow of information in the public security markets? Explain why information in the pub¬ lic security markets
What body sets financial accounting standards today? Is it a private body, a government body, or some combination of the two?
Each of the following quotes was taken from a well-known business publication. In each case comment on how the quote indicates an economic consequence.a. “Profits of public companies have the
The AICPA considered and passed a proposal that would bar accountants from borrow¬ ing from banks that their firms audit. Briefly explain why the AICPA would pass such a proposal.
Why should investors, creditors, managers, and consumers be concerned if auditors must charge higher fees due to increasing levels of legal liability and increasing liability insur¬ ance rates?
Suppose an accounting standard, which requires companies to report projections of earn¬ ings two years in the future, is presently being considered by the FASB. The FASB is now receiving letters
For years many individuals have claimed that public accounting firms should not be allowed to offer management advisory services to the same companies they audit. What is the rationale behind such
Moody’s Investors Service, Standard & Poor’s Corporation, and Dun & Bradstreet are well-known services that use publicly available financial information to provide ratings on the outstanding debt
Chuck Enis, a financial analyst, is studying firms in the pharmaceutical industry, hoping to find a solid investment. He is having difficulty comparing the performance levels of companies that are
Critique the following statement: Generally accepted accounting principles represent a precise and narrowly defined set of laws that are set by a council of accounting experts who insulate themselves
What body is currently involved in setting international accounting standards and why might its progress be slow?
Refer to the MCI annual report in Appendix C and answer the following questions.a. Briefly describe the operations of MCI and indicate whether the company is a man¬ ufacturer, retailer, or service
(Appendix 1A) E. W. Hauser and Associates showed $38,000 of net income on this past year’s income statement. Yet the tax form filed with the Internal Revenue Service indi¬ cated only $25,000 of
(Appendix 1A) Distinguish management accounting from financial accounting, and describe how the information provided by the two systems is used differently.
Explain how a company's business strategy affects financial analysis, p. 705 LO1
Discuss how analysts use financial statements, p. 706 LO1
Compute and interpret component percentages, p. 707 LO1
Compute and interpret profitability ratios, p. 709 LO1
Compute and interpret liquidity ratios, p. 714 LO1
Compute and interpret solvency ratios, p. 718 LO1
Compute and interpret market test ratios, p. 719 LO1
What are some of the primary items on financial statements about which creditors usually are concerned?LO1
Why are statement users interested in financial summaries covering several years? What is the primary limitation of long-term summaries?LO1
What is ratio analysis 7 Why is it useful?LO1
What does the debt-to-equity ratio reflect?LO1
What are market tests?LO1
Which of the following ratios is not used to analyze profitability?a. quality of income ratioc. quick ratiob. return on assetsd. return on equity LO1
Which of the following would not change the receivables turnover ratio for a retail company?a. increases in the retail prices of inventoryb. a change in credit policyc. increases in the cost incurred
Which of the following ratios is used to analyze liquidity?a. earnings per sharec. current ratiob. debt-to-equityd. both (a) and (c)
A decrease in selling and administrative expenses would impact what ratio?a. fixed asset turnover ratioc. debt-to-equity ratiob. times interest earnedd. current ratio
A large retailer reported revenue of $1,680,145,000. The company's gross profit percentage was 55.9 percent. What amount of cost of goods sold did the company report?

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