Chapter 2
Financial Statements: An Overview
True/False
Required: For each of the following items, indicate whether it is True or False, by placing a (T) or (F) in the space provided.
______1. The accounting equation is: Assets = Liabilities – Stockholders’ Equity.
______2. The owners of sole proprietorships and partnerships enjoy the feature of
unlimited liability.
______3. The Statement of Financial Position describes the firm’s resources and
claims to those resources.
______4. Stockholders’ equity is sometimes called the residual claim because owners can claim only what is left over after all creditor claims have been met.
______5. A classified balance sheet lists assets in order of how quickly they can be
converted into cash.
______6. Current assets are assets that are expected to be converted into cash or
expire within one year or one operating cycle, whichever is shorter.
______7. Common stock and retained earnings combined represent the amount
contributed by stockholders when they purchased shares from the company.
______8. Under the accrual concept, revenues are recorded as earned and expenses
are recorded when cash is paid.
______9. Under the indirect method of presenting the Statement of Cash Flows, net
income under the accrual concept is adjusted to its cash flow equivalent.
______10. A company’s annual report contains footnotes that describe significant
accounting policies employed by the firm.
Multiple Choice
Required: Select the one best answer and place its letter in the space provided.
______1. Each of the following forms of organization have the limited liability feature
except:
a.Corporations
b.LLCs.
c.LLPs.
d.Partnerships.
______2.Many public accounting firms are organized as:
a. Corporations.
b. LLCs.
c. LLPs.
d. Sole proprietorships.
______3. A disadvantage unique to the corporate form of organization is:
a.Double taxation.
b. Limited access to additional funds.
c. Difficulty in ownership transfer.
d. Unlimited liability.
______4. An advantage of the corporate form of organization is:
a. Income is taxed only once.
b. Limited liability.
c. Some sharing of risk.
d. Some access to additional funds.
______5. Each of the following represents liabilities except:
a. Accrued expenses.
b. Retained earnings.
c. Salaries payable.
d. Unearned revenues.
______6. An income statement consists of all of the following, except:
a. Interest expense.
b. Cost of goods sold.
c. Retained earnings.
d. Income taxes.
______7. Which of the financial statements is for a particular point in time?
a. Statement of Changes in Stockholders’ Equity
b.Statement of Earnings
c. Statement of Cash Flows
d.Statement of Financial Position
______8. Each of the following are included in stockholders’ equity except:
a. Additional paid-in capital.
b. Common stock.
c. Deferred taxes.
d. Retained earnings.
______9. Which of the following is not a current asset?
a. Inventory
b. Prepaid expenses
c. Equipment
d. Accounts receivable
______10.In a classified balance sheet, assets are listed:
a. Alphabetically.
b. In liquidity order.
c. From largest to smallest.
d. In order of acquisition.
______11. Which of the following is the accounting equation?
a. Assets = liabilities – stockholders’ equity
b. Assets = liabilities x stockholders’ equity
c. Assets = liabilities / stockholders’ equity
d. Assets = liabilities + stockholders’ equity
______12.Liabilities that become due, or expected to be settled, within one year are
classified as:
a. Accrued liabilities.
b. Current liabilities.
c. Long-term liabilities.
d. Non-current liabilities.
______13.The income statement contains all of the following, except:
a. Taxes payable.
b. Interest expense.
c. Revenues.
d. Cost of goods sold.
______14.Stockholders’ equity is also referred to as each of the following except:
a. Net assets.
b. Net book value.
c. A residual claim.
d. Each of the above is correct.
______15.Dividends declared are reported on the statement of:
a. Cash Flows.
b. Changes in Stockholders’ Equity.
c. Earnings.
d. Financial Position.
______16. Which of the following is not a major category in the balance sheet?
a. Assets
b. Liabilities
c. Retained earnings
d. Stockholders’ equity
______17.Which section of the balance sheet reflects the owners’ claim in a company?
a. Retained earnings
b. Assets
c. Liabilities
d. Stockholders’ equity
______18. Which of the following would typically be classified as a current liability?
a. Accrued payroll
b. A note payable due in 2 years
c. Mortgage payable
d. Bonds payable
______19.Cash inflows and outflows associated with the sales of goods to customers
are reported as
a. financing activities.
b. income activities.
c. investing activities.
d. operating activities.
______20.The starting point in the operating activities section of the statement of cash flows under the indirect method is:
a. Sales revenue.
b. Retained earnings.
c. Beginning cash balance.
d. Net earnings.
______21.In which section of the annual report does management provide its assessment of the past year’s operating results, liquidity, and capital expenditures?
a. Message from chief executive officer
b. Management’s discussion and analysis
c. Financial highlights
d. Statement of management’s responsibilities
______22. The acquisition or disposal of long term assets are reported as
a. financing activities.
b. investing activities.
c. operating activities.
d. purchasing activities.
______23.Which section of the annual report provides the reader with information about significant accounting policies employed by the firm?
a. Financial highlights
b. Notes to financial statements
c. Other corporate information
d. Management’s discussion and analysis
______24. The section of the annual report that establishes whether or not the financial statements are presented in conformity with accounting principles is called the:
a. Notes to financial statements.
b. Financial highlights.
c. Auditor’s report.
d. Management’s discussion and analysis.
______25.The issuance and repayment or repurchase of debt and equity is reported as
a. financing activities.
b. investing activities.
c. issuing activities.
d. operating activities.
______26. The Statement of Earnings is sometimes called each of the following except the
a. Income Statement.
b. Statement of Income.
c. Statement of Retained Earnings.
d. The Statement of Earnings is called all of the above options.
______27. Retained earnings is reported in the Statement of
a. Earnings
b. Financial Position only.
c. Changes in Stockholders’ Equity only.
d. Changes in Stockholders’ Equity and the Statement of Financial Position.
______28.Net earnings is reported in how many of the major financial statements?
a. one
b. two
c. three
d. four
______29.The financial statement that is prepared first is the Statement of
a. Cash Flows.
b. Changes in Stockholder Equity.
c. Earnings.
d. Financial Position.
______30. Depreciation expense is reported on the Statement of
a. Earnings only.
b. Financial Position.
c. Cash Flows only.
d. Earnings and the Statement of Cash Flows
______31.The ending cash balance is reported on the Statement of
a. Changes in Stockholders’ Equity.
b. Cash Flows only.
c. Financial Position only.
d. Financial Position and the Statement ofCash Flows.
______32.Accounting recognition of the revenues and expenses that go into the determination of net income are governed by the
a. accrual concept.
b. cash concept.
c. expense concept.
d. revenue concept.
______33.Income before income taxes equals sales less
a. cost of goods sold.
b. general and administrative costs.
c. all expenses.
d. all expenses except interest.
______34.General and administrative costs includes
a. cost of goods sold.
b. income taxes.
c. interest expense.
d. salaries and wages.
______35.A 10K report filed with the SEC contains financial statement information for a
a. month.
b. quarter.
c. week.
d. year.
______36.A 10Q report filed with the SEC includes financial information for a
a. month.
b. quarter.
c. week.
d. year.
______37.Which of the following financial statements is often called a balance sheet?
a. Statement of Changes in Stockholders’ Equity
b. Statement of Cash Flows
c. Statement of Earnings
d. Statement of Financial Position
______38.The financial statement that explains changes in stockholders’ equity arising from the firm’s operating activities is the Statement of
a. Cash Flows.
b. Changes in Stockholders’ Equity.
c. Earnings.
d. Financial Position.
______39.Each of the following financial statements describe changes in a firm’s financial position except the Statement of
a. Cash Flows.
b. Changes in Stockholders’ Equity.
c. Earnings.
d. Financial Position.
______40.The dominant form of business organization has become
a. corporations.
b. limited liability partnerships.
c. partnerships.
d. sole proprietorships.
Matching
1. (5 Minutes)
Listed below are a series of terms and a series of definitions.
Terms
A. Accrual conceptF. Indirect method
B. Balance sheetG. Limited Liability
C. Cost of goods soldH. Net asset
D. Current assetsI. Retained earnings
E. Fiscal yearJ. Statement of Earnings
Definitions
______1. Accumulated amount of net income less dividends distributed to stockholders since the company formed.
______2.Net income under the accrual concept is adjusted to its cash flow equivalent.
______3.The difference between what a company owns and what it owes.
______4.Investors cannot lose more than the amounts that they invest should the firm perform poorly.
______5.Explains changes in stockholders’ equity arising from the firm’s operating activities.
______6.The expense recorded when inventory is sold.
______7.The SEC requires firms to report balance sheet data at the end of this time.
______8.Revenues are recorded as earned and expenses are recorded as incurred.
______9.Reports a firm’s assets, liabilities, and stockholders’ equity at a particular point in time.
______10.Assets that are expected to be converted into cash or expire within one year or the operating cycle, whichever is longer.
Required:
Match each term to the appropriate definition by placing its letter in the space provided.
Exercises
1. (5 minutes)
Using the following abbreviations, classify where the items listed below would appear
in the financial statements.
CA: Current Assets
NCA: Noncurrent Assets
CL: Current Liabilities
NCL: Noncurrent Liabilities
SE: Stockholders’ Equity
IS: Income Statement Item
CF: Cash Flow Statement Item
______1. Additional Paid-in Capital______6. Cost of Goods Sold
______2. Prepaid Expenses______7. Land
______3. Salaries Payable______8. Retained Earnings
______4. Sales______9. Accounts Receivable
______5. Dividends Paid______10. Notes Payable (due in 2008)
2. (10 minutes)
The following data was taken from the books of Oceanside Corporation as of December
31, 2006:
Accounts Payable$9,000Salaries Payable$48,000
Cost of Goods Sold295,000Selling Expense60,000
Cash15,000General Expense60,000
Long-Term Notes Payable20,000Accounts Receivable12,000
Sales Revenue450,000Prepaid Insurance5,000
Inventory50,000Income Tax Expense30,000
Common Stock90,000Equipment71,000
Retained Earnings, BB55,000Buildings74,000
Required:
Prepare an unclassified balance sheet. (Note: You must compute the ending balance of retained earnings.)
3. (4 minutes)
Using the following abbreviations, classify each of the transactions listed below as operating, investing, or financing activities.
OA: Operating Activity
IA: Investing Activity
FA: Financing Activity
______1. Dividends paid
______2. Cash paid to suppliers
______3. Purchase of equipment
______4. Issuance of common stock
______5. Payments received on notes receivable
______6. Cash received from customers
______7. Purchase of treasury stock
______8. Sale of property
Short Answer
1. (5 minutes)
Identify the three principal features (advantages) of corporations.
2. (7 minutes)
Identify the major financial statements and briefly explain what information each presents.
3. (5 minutes)
List four items (sections) of a company’s annual report other than the financial statements.
Essays
1. (8 minutes)
Identify the advantages and disadvantages of the main forms of business organization.
2. (10 minutes)
Define the three sections of the Statement of Financial Position and give examples of items included in each of the sections.
Answers
True/False
1. F5. T9. T
2. F6. F10. T
3. T7. F
4. T8. F
Multiple Choice
1. d10. b19. d28. c37. d
2. c11. d20. d29. c38. c
3. a12. b21. b30. d39. d
4. b13. a22. b31. d40. a
5. b14. d23. b32. a
6. c15. b24. c33. c
7. d16. c25. a34. d
8. c17. d26. c35. d
9. c18. a27. d36. b
Matching
1. I4. G7. E10. D
2. F5. J8. A
3. H6. C9. B
Exercises
1.) 1. SE6. IS
2. CA7. NCA
3. CL8. SE
4. IS9. CA
5. CF10. NCL
2.) Oceanside Corporation
Balance Sheet
December 31, 2006
AssetsLiabilities
Cash$15,000Salaries Payable48,000
Accounts Receivable12,000Accounts Payable$9,000
Inventory50,000Income Tax Payable40,000
Prepaid Insurance5,000Long-Term Notes Payable20,000
Equipment120,000Total Liabilities117,000
Stockholders’ Equity
Common Stock90,000
Retained Earnings43,000
Total Stockholders’ Equity133,000
Total Liabilities & Stockholders’
Total Assets$202,000Equity $202,000
3.)
1. FA5. IA
2. OA6. OA
3. IA7. FA
4. FA8. IA
Short Answers
1. The corporate form of business has three principal features (advantages). These are: limited liability for its investors, ease of transferring ownership, and ease of access to additional funds.
2. The major financial statements are the: Statement of Financial Position, Statement of Earnings, Statement of Cash Flows and Statement of Changes in Stockholders’ Equity. The Statement of Financial Position presents the firm’s resources and claims to those resources. The Statement of Earnings explains changes in stockholders’ equity arising from the firm’s operating activities. The Statement of Cash Flows shows how investing, financing, and operating activities affect cash. The Statement of Changes in Stockholders’ Equity provides details about all of the transactions that affect stockholders’ equity.
3. A company’s annual report includes the following items (sections) in addition to the financial statements: 1) message from Chief Executive Officer, 2) Description of Principal Products, 3) Financial Highlights, 4) Management’s Discussion and Analysis, 5) Notes to Financial Statements, 6) Statement of Management’s Responsibilities, and 7) the Auditor’s Report (only four need to be listed).
Essays
1. The proprietorship form has the advantage of not paying taxes as a business entity (income is taxed only at the individual level) but has several disadvantages – unlimited liability, no sharing of risk, and limited access to additional funds. The partnership form also has the advantage of the business not being taxed as a business entity but income being taxed at the individual’s rate and has some access to additional funds. Its disadvantages include unlimited liability and difficulty in ownership transfer. The corporate form has the advantages of limited liability and ease of transfer of ownership. It does have the disadvantage of double taxation.
2. The Statement of Financial Position has three sections: assets, liabilities, and stockholders’ equity. Assets are those resources owned by a company or those that a company has the right to use. Examples include cash, inventories, and property and equipment. Liabilities represent the amounts owed to others and include notes payable, accounts payable, and accrued expenses. Stockholders’ equity is the difference between what a company owns and what it owes. Examples include common stock, additional paid-in capital, and retained earnings.