Chapter 2
Investing and Financing Decisions and
the Accounting System
ANSWERS TO QUESTIONS
1. (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 monetary unit assumption requires information to be reported in the
national monetary unit without any adjustment for changes in purchasing
power. That means that each business will account for and report its financial
results primarily in terms of the national monetary unit, such as Yen in Japan
and Australian dollars in Australia.
(c) Under the 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 is a measurement model that 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 noncash
considerations.
2. 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.
3. (a) An asset is an economic resource owned or controlled by a company; it has
measurable value and is expected to benefit the company by producing cash
inflows or reducing cash outflows in the future.
(b) A current asset is an asset that will be used or turned into cash within one year.
(c) A liability is a measurable obligation resulting from a past transaction; it is
expected to be settled in the future by transferring assets or providing services.
(d) A current liability is a short-term obligation that will be paid in cash (or other
current assets) within the current operating cycle or one year, whichever is
longer.
(e) Additional paid-in capital is the owner-provided financing to the business that
represents the amount of contributed capital less the par value of the stock.
Financial Accounting, 11/e 2-1
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, (f) Retained earnings are the cumulative earnings of a company that are not
distributed to the owners and are reinvested in the business.
4. An account is a standardized format used by organizations to accumulate the dollar
effects of transactions on each financial statement item.
5. The accounting equation is: Assets = Liabilities + Stockholders' Equity
6. A business transaction is:
(a) an exchange of resources (assets) and obligations (debts) between a business
and one or more outside parties, and
(b) a measurable internal event that directly affects the entity but where there is no
exchange with external parties.
An example of situation (a) is the sale of goods or services to customers.
An example of situation (b) is the use of equipment in operations.
7. Debit is the left side of a journal entry and T-account and credit is the right side of a
journal entry and T-account. A debit is an increase in assets and a decrease in
liabilities and stockholders' equity. A credit is the opposite -- a decrease in assets and
an increase in liabilities and stockholders' equity.
8. 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 + Stockholders' 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 three steps in transaction analysis are:
(1) determine what the company received: identify and classify accounts
and the direction and amount of the effects.
(2) determine what the company gave: identify and classify accounts
and the direction and amount of the effects.
(3) determine that the accounting equation (A = L + SE) remains in
balance.
9. The equalities that must be maintained in transaction analysis are:
(a) Assets = Liabilities + Stockholders' Equity
(b) Debits = Credits
10. A journal entry is an accounting method for expressing the effects of a transaction on
accounts in a debits-equal-credits format. The title(s) of the account(s) to be debited
is (are) listed first and the title(s) of the account(s) to be credited is (are) listed
underneath the debited accounts. The debited amounts are placed in a left-hand
column and the credited amounts are placed in a right-hand column.
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,11. 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.
12. The current ratio is computed as current assets divided by current liabilities. It
measures a company’s liquidity -- the ability of the company to pay its short-term
obligations with current assets. A ratio above 1.0 normally suggests that the company
has sufficient current assets to settle short-term obligations. Sophisticated cash
management systems allow many companies to minimize funds invested in current
assets and have a current ratio below 1.0. However, a ratio that is too high in relation
to other competitors in the industry may indicate inefficient use of resources.
13. 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 stock, and paying dividends.
Financial Accounting, 11/e 2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, MULTIPLE CHOICE
1. d 6. c
2. d 7. a
3. a 8. d
4. a 9. b
5. d 10. a
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© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
Investing and Financing Decisions and
the Accounting System
ANSWERS TO QUESTIONS
1. (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 monetary unit assumption requires information to be reported in the
national monetary unit without any adjustment for changes in purchasing
power. That means that each business will account for and report its financial
results primarily in terms of the national monetary unit, such as Yen in Japan
and Australian dollars in Australia.
(c) Under the 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 is a measurement model that 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 noncash
considerations.
2. 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.
3. (a) An asset is an economic resource owned or controlled by a company; it has
measurable value and is expected to benefit the company by producing cash
inflows or reducing cash outflows in the future.
(b) A current asset is an asset that will be used or turned into cash within one year.
(c) A liability is a measurable obligation resulting from a past transaction; it is
expected to be settled in the future by transferring assets or providing services.
(d) A current liability is a short-term obligation that will be paid in cash (or other
current assets) within the current operating cycle or one year, whichever is
longer.
(e) Additional paid-in capital is the owner-provided financing to the business that
represents the amount of contributed capital less the par value of the stock.
Financial Accounting, 11/e 2-1
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, (f) Retained earnings are the cumulative earnings of a company that are not
distributed to the owners and are reinvested in the business.
4. An account is a standardized format used by organizations to accumulate the dollar
effects of transactions on each financial statement item.
5. The accounting equation is: Assets = Liabilities + Stockholders' Equity
6. A business transaction is:
(a) an exchange of resources (assets) and obligations (debts) between a business
and one or more outside parties, and
(b) a measurable internal event that directly affects the entity but where there is no
exchange with external parties.
An example of situation (a) is the sale of goods or services to customers.
An example of situation (b) is the use of equipment in operations.
7. Debit is the left side of a journal entry and T-account and credit is the right side of a
journal entry and T-account. A debit is an increase in assets and a decrease in
liabilities and stockholders' equity. A credit is the opposite -- a decrease in assets and
an increase in liabilities and stockholders' equity.
8. 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 + Stockholders' 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 three steps in transaction analysis are:
(1) determine what the company received: identify and classify accounts
and the direction and amount of the effects.
(2) determine what the company gave: identify and classify accounts
and the direction and amount of the effects.
(3) determine that the accounting equation (A = L + SE) remains in
balance.
9. The equalities that must be maintained in transaction analysis are:
(a) Assets = Liabilities + Stockholders' Equity
(b) Debits = Credits
10. A journal entry is an accounting method for expressing the effects of a transaction on
accounts in a debits-equal-credits format. The title(s) of the account(s) to be debited
is (are) listed first and the title(s) of the account(s) to be credited is (are) listed
underneath the debited accounts. The debited amounts are placed in a left-hand
column and the credited amounts are placed in a right-hand column.
2-2 Solutions Manual
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
,11. 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.
12. The current ratio is computed as current assets divided by current liabilities. It
measures a company’s liquidity -- the ability of the company to pay its short-term
obligations with current assets. A ratio above 1.0 normally suggests that the company
has sufficient current assets to settle short-term obligations. Sophisticated cash
management systems allow many companies to minimize funds invested in current
assets and have a current ratio below 1.0. However, a ratio that is too high in relation
to other competitors in the industry may indicate inefficient use of resources.
13. 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 stock, and paying dividends.
Financial Accounting, 11/e 2-3
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
, MULTIPLE CHOICE
1. d 6. c
2. d 7. a
3. a 8. d
4. a 9. b
5. d 10. a
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