ANSWERS TO QUESTIONS

Financial Accounting, 6ce, Libby, Libby, Short, Kanaan, Sterling © 2017 McGraw-Hill Education Limited. All rights reserved.2-1 Chapter 2 Investing and Financing Decisions and the Statement of Financial Position

Revised: February 23, 2017

ANSWERS TO QUESTIONS

• The primary objective of financial reporting for external users is to provide useful

financial information about a business to help external parties, primarily investors and creditors, make sound financial decisions. These users are expected to have a reasonable understanding of accounting concepts and procedures. Usually, they are interested in information to assist them in projecting future cash inflows and outflows of a business.

• (a) An asset is an economic resource controlled by an entity as a result of a past

transaction or event and from which future economic benefits may be obtained.(b)A current asset is an asset that will be used or turned into cash within one year; inventory is always considered a current asset regardless of how long it takes to produce and sell the inventory.(c)A liability is a probable debt or obligation of the entity as a result of a past transaction, which will be paid with assets or services.(d)A current liability is a liability that will be paid in cash (or other current assets) or satisfied by providing service within the coming year.(e)Contributed capital is cash (and sometimes other assets) provided to the business by owners.(f)Retained earnings are the cumulative net earnings of a company that are not distributed to the owners and are reinvested in the business.Financial Accounting Canadian 6th Edition Libby Solutions Manual Visit TestBankDeal.com to get complete for all chapters

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• To be useful, information must be relevant; that is, it must be timely and have

predictive and/or feedback value. Relevant information is any information that is likely to change an investor’s decision. However, if the information is not a faithful representation of the economic phenomena it is supposed to represent (complete, neutral and free from material error) it will not be trusted, and thus will not be useful.

• (a) The separate-entity assumption requires that business transactions are separate

from the transactions of the owners. For example, the purchase of a truck by the owner for personal use is not recorded as an asset of the business.(b)The unit-of-measure assumption requires information to be reported in the national monetary unit. That means that each business will account for and report its financial results primarily in terms of the national monetary unit, such as Euros in Germany and Australian dollars in Australia.(c)Under the continuity or going-concern assumption, businesses are assumed to operate into the foreseeable future. That is, they are not expected to liquidate.(d)The (historical) cost principle requires assets to be recorded at the cash- equivalent cost on the date of the transaction. Cash-equivalent cost is the cash paid plus the dollar value of all non-cash considerations.

• Accounting assumptions are necessary because they reflect the scope of accounting

and the expectations that set certain limits on the way accounting information is reported.

• The current ratio is computed as current assets divided by current liabilities. It

measures the ability of the company to pay its short-term obligations with current assets. A high ratio normally suggests good liquidity, but a ratio that is too high may include inefficient use of resources. The general rule was a ratio between 1.0 and 2.0 (twice as many current assets as current liabilities), but sophisticated cash management systems allow many companies to minimize funds invested in current assets and have a current ratio below 1.0.

• An account is a standardized format used by organizations to accumulate the dollar

effects of transactions on each financial statement item. Accounts are necessary to keep track of all increases and decreases in the fundamental accounting model.

• Historical cost reflects the market value of an asset at the time of acquisition. However,

the continued reporting of historical cost subsequent to acquisition does not reflect any change in market value. Accountants continue to report historical costs on statements of financial position because they are more verifiable and objective measures than market values.

Financial Accounting, 6ce, Libby, Libby, Short, Kanaan, Sterling © 2017 McGraw-Hill Education Limited. All rights reserved.2-3

9. The fundamental accounting model is provided by the equation:

Assets = Liabilities + Shareholders’ Equity

• A business transaction is (a) external - an exchange of resources (assets) and obligations

(debts) between a business and one or more outside parties, and (b) internal - certain events that have a direct and measurable effect on the business. An example of the first situation (a) is the sale of goods or services. An example of the second situation (b) is a loss incurred due to a fire.

• Debit is the left side of a T-account and credit is the right side of a T-account. Debits

increase asset accounts, and decrease liability and shareholders’ equity accounts.Credits decrease asset accounts, and increase liability and shareholders’ equity accounts.

• Transaction analysis is the process of studying a transaction to determine its economic

effect on the entity in terms of the accounting equation:

Assets = Liabilities + Shareholders’ Equity

The two principles underlying the process are:

• every transaction affects at least two accounts.
• the accounting equation must remain in balance after each transaction.

The two steps in transaction analysis are:

(1) identify and classify accounts and effects.(2) determine that the accounting equation (A = L + SE) remains in balance.

13. The equalities in accounting are:

(a) Assets = Liabilities + Shareholders’ Equity (b) Debits = Credits

• The journal entry is a method for expressing the effects of a transaction on accounts in a

debits equal credits format. The title of the account(s) to be debited is (are) listed first.The title of the account(s) to be credited is (are) listed underneath the debited account(s), and the account title(s) and amount(s) credited is (are) indented to the right.

• The T-account is a tool for summarizing transaction effects for each account, determining

balances, and drawing inferences about a company's activities. It is a simplified representation of a ledger account with a debit column on the left and a credit column on the right.

• Investing activities on the statement of cash flows include the buying and selling of

productive assets and investments. Financing activities include borrowing and repaying debt, issuing and repurchasing shares, and paying dividends.

Financial Accounting, 6ce, Libby, Libby, Short, Kanaan, Sterling © 2017 McGraw-Hill Education Limited. All rights reserved.2-4

• Bookkeeping is only one part of accounting. A bookkeeper records the routine

transactions in most businesses and may maintain the records of a small business. An accountant is a highly trained professional, competent in the design of information systems, analysis of complex transactions, interpretation of financial data, financial reporting, auditing, taxation, and management consulting.