COVERAGE OF LEARNING OBJECTIVES

CHAPTER 2

COVERAGE OF LEARNING OBJECTIVES

LEARNING QUESTIONS EXERCISES PROBLEMS OTHER

OBJECTIVES

LO1: Explain how

accountants measure income. 1,2,3,4,26,27 32, 36 45,49,51 67 LO2: Determine when a company should record revenue from a sale. 5,6 31 45,46,49,51,61 67 LO3: Use the concept of matching to record the expenses for a period. 7,8,9 34, 36 45,47,48,50,

52,53,54,56

LO4: Prepare an income statement and show how it is related to a balance sheet. 10,11,12 30,35,36,37,38,39, 40,41

45,47,48,50,52, 53,54,55, 56,57,58 65,66,67

LO5: Account for cash

dividends and prepare a statement of stockholders’ equity.

13,14,15, 28 33,35, 38,

39,40

54,55,57,58 65,66

LO6: Compute and

explain earnings per share, price-earnings ratio, dividend-yield ratio, and dividend- payout ratio.

17,18,19,20,29 42,43 59, 60 64,66

LO7: Explain how the conceptual framework guides the standard setting process and how accounting regulators trade off relevance and faithful representation in setting accounting standards. 21,22,23 62 LO8: Explain how the following concepts affect financial statements: entity, going concern, materiality, stable monetary unit, periodicity and reliability. 16,24,25,26 44 63 27 Copyright  ©2014  Pearson Education, Inc.Introduction to Financial Accounting 11th Edition Horngren Solutions Manual Visit TestBankDeal.com to get complete for all chapters

CHAPTER 2

2-1 The length of the operating cycle depends on the nature of the company. It is the time it takes the company to use cash to acquire goods and services, to sell those goods and services to customers, and to collect cash from the sales.

2-2 A fiscal year is the year used for financial reporting. It may be the same as a calendar year, but often it is not. Many companies elect to begin and end a fiscal year at the low point in their annual business activity.

2-3 Expenses are reductions in stockholders’ equity; thus they may be described as negative stockholders’ equity accounts.

2-4 The cash basis fails to match accomplishments with efforts in a single accounting period.In particular, the cash basis fails to match revenues and expenses properly. Inventory may be bought and paid for in one period, and sold in the second with the collection from customers in a third period. Accrual accounting matches revenue and cost of goods sold in the second period, although the cash outlay occurred in the first and the collection was made in the third.

2-5 The two criteria for revenue recognition are earning and realization (realized or realizable).

2-6 Revenue recognition is delayed when a company sells a magazine subscription because the company does not recognize revenue until it is earned by delivery of the magazines.Revenue recognition is also delayed if collection of the account receivable is not reasonably certain, which means that it is not realized or realizable. This may happen with speculative land sales.

2-7 Product costs are naturally linked to revenues, while period costs support a company’s operations for a given period. Product costs become expenses when the company recognizes the related revenue. Period costs become expenses in the period in which they are incurred.

2-8 In theory, all expenses are goods and services that were first purchased as assets and that have now been consumed or used in the conduct of operations.

2-9 Managers acquire assets (goods and services) that are then either used instantaneously or at a later time. When the assets are used, they become expenses.

2-10 The balance sheet is a financial picture of a company at one point in time, like a snapshot. In contrast, an income statement shows activity over a period of time. It shows the series of events that take a company from one “snapshot” (balance sheet) to another, just as a moving picture shows movement from one position to the next.

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2-11 Synonyms for the income statement include statement of earnings, statement of operations, and operating statement. A major reason to learn accounting is to be able to read real financial statements. Such statements contain a variety of terms that may differ from the one first leaned in an introductory accounting course. To be able to read and interpret the financial statements, users need to understand the terminology, including synonyms used for the major accounting terms.

2-12 Managers are often optimistic and feel that things are bound to get better, so they do not like to report bad news. In addition, they may have bonuses or possible promotions that depend on the financial results, so they want the reports to be as good as possible.Finally, financial reports are often the “scorecard” for business success, and competitive managers want to report a high score.

2-13 Cash dividends are not necessary in the conduct of revenue-producing operations.Therefore, they are not expenses but are voluntary distributions of assets to owners.These distributions are made possible because of profitable operations, but are not part of the profitable operations.

2-14 Retained earnings is a stockholders’ equity account (a residual claim against assets), and not an asset account. It is a claim against resources, not a resource itself.

2-15 The statement of stockholders’ equity provides information on what caused the stockholders’ equity accounts to change during a given period. The three main items that affect stockholders’ equity are net income, transactions with stockholders (sale of stock, distribution of dividends), and other comprehensive income—a catch-all category of all equity changes that are neither part of net income nor arise from transactions with owners.

2-16 No. An accounting entity can be a part of an organization, such as a division or department. It can also be an entire economy, such as national income accounting for the United States or another country.

2-17 No. One financial ratio, earnings per share (EPS), is presented on the income statement.

2-18 A high P-E ratio suggests that investors expect future earnings to significantly exceed current earnings. This is likely to be true for fast growing companies.

2-19 Two dividend ratios are as follows:

• Dividend-yield ratio—The amount of dividends paid per dollar invested in a stock at the current market price. The dividend-yield ratio is computed as Dividends per share ÷ Market price per share.• Dividend-payout ratio—The percentage of a company’s earnings that is paid out in dividends The dividend-payout ratio is computed as Dividends per share ÷ EPS.

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2-20 No. A high dividend-payout ratio may be a bad sign. Companies with a high dividend- payout ratio tend to be slow-growing companies. They return a larger percentage of their income to shareholders because they do not have profitable opportunities in which to invest.

2-21 Yes, accountants make many trade-offs between relevance and faithful representation.Although both are desirable characteristics, sometimes it is necessary to sacrifice some of one to gain much of the other. A major trade-off is between market values, which are often more relevant but may raise questions about faithful representation, and historical costs, which faithfully represent an event but may be less relevant.

2-22 The two main characteristics that make accounting information relevant are predictive value—meaning that it helps users form their expectations about the future—and confirmatory value—meaning that it can confirm or contradict existing expectations.

2-23 These criteria support faithful representation. They help ensure that information truly captures the economic substance of the transactions, events, or circumstances it describes.

2-24 Reliable data require convincing evidence that can be verified by independent auditors.Accountants must make sure that data reported in the financial statements can be measured with enough accuracy to be useful to users of the statements.

2-25 Materiality means that items that are not large enough to influence users’ decisions can be omitted from the financial statements. Thus, you do not find pencils or paper clips listed separately among a company’s assets. Cost-benefit means, for example, that if the cost of measuring an item is greater than the value from knowing it, the item can be omitted. Thus, the financial statements of a division of a company may not include an expense for any portion of the company president’s salary, even though the president spends time overseeing the division’s activities. It would simply be too costly for the president to account for each minute spent on each different activity he or she undertakes, and there is little benefit to attempting to allocate the president’s salary to individual divisions. However, in the corporate financial statements, the president’s salary would be treated as an operating cost assigned to the corporation as a whole.

2-26 A year is a long time to wait for new information about a company’s performance.Preparing full financial statements is time consuming and costly. Quarterly financial disclosures are less complete than annual ones, but they represent a balanced answer to how often and how complete information should be. Within companies, managers get financial reports daily, weekly, or monthly depending on their needs. In different countries the tradition and the identity of investors have led to different customs. The United States relies on public ownership of companies and needs a system to keep large numbers of investors adequately informed. In countries where more of the ownership is closely held and more of the liabilities are bank financed, there is less need for frequent public disclosure.30 Copyright  ©2014  Pearson Education, Inc.