Review Questions - 1-1 Chapter 1 Accounting and the Business Envir...

© 2018 Pearson Education, Inc.1-1 Chapter 1 Accounting and the Business Environment

Review Questions

• Accounting is the information system that measures business activities, processes the information

into reports, and communicates the results to decision makers. Accounting is the language of business.

• Financial accounting provides information for external decision makers, such as outside investors,

lenders, customers, and the federal government. Managerial accounting focuses on information for internal decision makers, such as the company’s managers and employees.

• Individuals use accounting information to help them manage their money, evaluate a new job, and

better decide whether they can afford to make a new purchase. Business owners use accounting information to set goals, measure progress toward those goals, and make adjustments when needed.Investors use accounting information to help them decide whether or not a company is a good investment and once they have invested, they use a company’s financial statements to analyze how their investment is performing. Creditors use accounting information to decide whether to lend money to a business and to evaluate a company’s ability to make the loan payments. Taxing authorities use accounting information to calculate the amount of income tax that a company has to pay.

• Certified Public Accountants (CPAs) are licensed professional accountants who serve the general

public. They work for public accounting firms, businesses, government, or educational institutions.To be certified they must meet educational and/or experience requirements and pass an exam.Certified Management Accountants (CMAs) specialize in accounting and financial management knowledge. They work for a single company.

• The FASB oversees the creation and governance of accounting standards. They work with

governmental regulatory agencies, congressionally created groups, and private groups.

• The guidelines for accounting information are called GAAP. It is the main U.S. accounting rule

book and is currently created and governed by the FASB. Investors and lenders must have information that is relevant and has faithful representation in order to make decisions and GAAP provides the framework for this financial reporting.

• A sole proprietorship has a single owner, terminates upon the owner’s death or choice, the owner has

personal liability for the business’s debts, and it is not a separate tax entity. A partnership has two or more owners, terminates at partner’s choice or death, the partners have personal liability, and it is not a separate tax entity. A corporation is a separate legal entity, has one or more owners, has indefinite life, the stockholders are not personally liable for the business’s debts, and it is a separate tax entity. A limited-liability company has one or more members and each is only liable for his or her own actions, has an indefinite life, and is not a separate tax entity.

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© 2018 Pearson Education, Inc.1-2

• The land should be recorded at $5,000. The cost principle states that assets should be recorded at

their historical cost.

• The going concern assumption assumes that the entity will remain in business for the foreseeable

future and long enough to use existing resources for their intended purpose.

• The faithful representation concept states that accounting information should be complete, neutral,

and free from material error.

• The monetary unit assumption states that items on the financial statements should be measured in

terms of a monetary unit.

• The IASB is the organization that develops and creates IFRS which are a set of global accounting

standards that would be used around the world.

• Assets = Liabilities + Equity. Assets are economic resources that are expected to benefit the

business in the future. They are things of value that a business owns or has control of. Liabilities are debts that are owed to creditors. They are one source of claims against assets. Equity is the other source of claims against assets. Equity is the stockholders’ claims against assets and is the amount of assets that is left over after the company has paid its liabilities. It represents the net worth of the corporation.

• Retained earnings increases with revenues. Retained earnings decreases with expenses and

dividends.

• Revenues – Expenses = Net Income. Revenues are earnings resulting from delivering goods or

services to customers. Expenses are the cost of selling goods or service.

• Step 1: Identify the accounts and the account type. Step 2: Decide if each account increases or

decreases. Step 3: Determine if the accounting equation is in balance.

• Income Statement – Shows the difference between an entity’s revenues and expenses and reports the

net income or net loss for a specific period.Statement of Retained Earnings – Shows the changes in retained earnings for a specific period including net income (loss) and dividends.Balance Sheet – Shows the assets, liabilities, and stockholders’ equity of the business as of a specific date.Statement of Cash Flows – Shows a business’s cash receipts and cash payments for a specific period.

• Return on Assets = Net income / Average total assets. ROA measures how profitably a company

uses its assets.

© 2018 Pearson Education, Inc.1-3 Short Exercises

S1-1

• FA e. MA
• FA f. FA
• FA g. MA
• MA h. FA

S1-2

The Financial Accounting Standards Board governs the majority of guidelines, called Generally Accepted Accounting Principles (GAAP), that the CPA will use to prepare financial statements for Wholly Shirts.

S1-3

Chloe’s needs will best be met by organizing a corporation since a corporation has an unlimited life and is a separate tax entity. In addition, the owners (stockholders) have limited liability. Chloe could also consider a limited liability company (LLC) as an option. A LLC meets two of the three criteria. It has an unlimited life and limited liability for the owner. However, a LLC is not a separate tax entity.

S1-4

Advantages:

• Easy to organize.
• Unification of ownership and management.
• Less government regulation.
• Owner has more control over business.

Disadvantages:

• The owner pays taxes on the entity’s earnings since it is not a separate tax entity.
• No continuous life or transferability of ownership.
• Unlimited liability of owner for business’s debts.

S1-5

• The economic entity assumption

• The cost principle.
• The monetary unit assumption.
• The going concern assumption.

© 2018 Pearson Education, Inc.1-4 S1-6 Requirement 1

Thompson Handyman Services has equity of $9,350.

Assets = Liabilities + Equity

$18,400 = $9,050 + ?

$18,400 = $9,050 + $9,350

Requirement 2

Thompson Handyman Services has liabilities of $17,200.

Assets = Liabilities + Equity

$18,400 + $4,300 = ? + $9,350 – $3,850

$22,700 = $17,200 + $5,500

S1-7 Requirement 1

ASSETS = LIABILITIES + EQUITY

Contributed Capital

• Retained Earnings

+ Common Stock – Dividends + Revenues – Expenses

$45,800

$45,800

= =

$17,220

$17,220

+ +

$27,460

$27,460

– –

$6,500

$6,500

+ +

$8,850

$8,850

– – ?

$1,230

Requirement 2

Roland’s Overhead Doors reported net income of $7,620. Net Income = Revenues ($8,850) – Expenses

($1,230)

S1-8

• L f. E
• A g. A
• E h. E
• A i. A
• E
• E