,Chapter F:1
Accounting and the Business Environment
Review Questions
1. What is accounting?
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.
2. Briefly describe the two major fields of accounting.
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.
3. Describe the various types of individuals who use accounting information and how they use that
information to make important decisions.
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.
4. What are various certifications available for accountants? Briefly explain each certification.
Certified Public Accountants (CPAs) are licensed professional accountants who serve the general
public. They work for public accounting firms, businesses, government, or educational institutions.
A Chartered Global Management Accountant (CGMA) is an accountant who has advanced
knowledge in finance, operations, strategy, and management. Certified Management Accountants
(CMAs) specialize in accounting and financial management knowledge. They work for a single
company. Certified Financial Planners (CFPs) work with individuals to help them budget, plan for
retirement, save for education, and manage their finances.
5. What is the role of the Financial Accounting Standards Board (FASB)?
The FASB oversees the creation and governance of accounting standards. They work with
governmental regulatory agencies, congressionally created groups, and private groups.
© 2024 Pearson Education, Ltd. 1-1
,6. Explain the purpose of Generally Accepted Accounting Principles (GAAP), including the
organization currently responsible for the creation and governance of these standards in the United
States.
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.
7. Describe the similarities and differences among the four different types of business entities discussed
in the chapter.
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.
8. A business purchases an acre of land for $5,000. The current market value is $5,550, and the land
was assessed for property tax purposes at $5,250. What value should the land be recorded at, and
which accounting principle supports your answer?
The land should be recorded at $5,000. The cost principle states that assets should be recorded at
their historical cost.
9. What does the going concern assumption mean for a business?
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.
10. Which concept states that accounting information should be complete, neutral, and free from
material error?
The faithful representation concept states that accounting information should be complete, neutral,
and free from material error.
11. Financial statements in the United States are reported in U.S. dollars. What assumption supports this
statement?
The monetary unit assumption states that items on the financial statements should be measured in
terms of a monetary unit.
12. Explain the role of the International Accounting Standards Board (IASB) in relation to International
Financial Reporting Standards (IFRS).
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.
© 2024 Pearson Education, Ltd. 1-2
, 13. What is the accounting equation? Briefly explain each of the three parts.
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.
14. How does retained earnings increase? What are the two ways that retained earnings decreases?
Retained earnings increases with revenues. Retained earnings decreases with expenses and
dividends.
15. How is net income calculated? Define revenues and expenses.
Revenues – Expenses = Net Income. Revenues are earnings resulting from delivering goods or
services to customers. Expenses are the cost of selling goods or service.
16. What are the steps used when analyzing a business transaction?
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.
17. List the financial statements discussed in the chapter and briefly describe each statement.
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. For public companies, the statement of retained earnings
is often included in a statement of stockholders’ equity.
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.
18. What is the calculation for ROA? Explain what ROA measures.
Return on Assets = Net income / Average total assets. ROA measures how profitably a company
uses its assets.
© 2024 Pearson Education, Ltd. 1-3
Accounting and the Business Environment
Review Questions
1. What is accounting?
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.
2. Briefly describe the two major fields of accounting.
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.
3. Describe the various types of individuals who use accounting information and how they use that
information to make important decisions.
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.
4. What are various certifications available for accountants? Briefly explain each certification.
Certified Public Accountants (CPAs) are licensed professional accountants who serve the general
public. They work for public accounting firms, businesses, government, or educational institutions.
A Chartered Global Management Accountant (CGMA) is an accountant who has advanced
knowledge in finance, operations, strategy, and management. Certified Management Accountants
(CMAs) specialize in accounting and financial management knowledge. They work for a single
company. Certified Financial Planners (CFPs) work with individuals to help them budget, plan for
retirement, save for education, and manage their finances.
5. What is the role of the Financial Accounting Standards Board (FASB)?
The FASB oversees the creation and governance of accounting standards. They work with
governmental regulatory agencies, congressionally created groups, and private groups.
© 2024 Pearson Education, Ltd. 1-1
,6. Explain the purpose of Generally Accepted Accounting Principles (GAAP), including the
organization currently responsible for the creation and governance of these standards in the United
States.
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.
7. Describe the similarities and differences among the four different types of business entities discussed
in the chapter.
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.
8. A business purchases an acre of land for $5,000. The current market value is $5,550, and the land
was assessed for property tax purposes at $5,250. What value should the land be recorded at, and
which accounting principle supports your answer?
The land should be recorded at $5,000. The cost principle states that assets should be recorded at
their historical cost.
9. What does the going concern assumption mean for a business?
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.
10. Which concept states that accounting information should be complete, neutral, and free from
material error?
The faithful representation concept states that accounting information should be complete, neutral,
and free from material error.
11. Financial statements in the United States are reported in U.S. dollars. What assumption supports this
statement?
The monetary unit assumption states that items on the financial statements should be measured in
terms of a monetary unit.
12. Explain the role of the International Accounting Standards Board (IASB) in relation to International
Financial Reporting Standards (IFRS).
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.
© 2024 Pearson Education, Ltd. 1-2
, 13. What is the accounting equation? Briefly explain each of the three parts.
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.
14. How does retained earnings increase? What are the two ways that retained earnings decreases?
Retained earnings increases with revenues. Retained earnings decreases with expenses and
dividends.
15. How is net income calculated? Define revenues and expenses.
Revenues – Expenses = Net Income. Revenues are earnings resulting from delivering goods or
services to customers. Expenses are the cost of selling goods or service.
16. What are the steps used when analyzing a business transaction?
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.
17. List the financial statements discussed in the chapter and briefly describe each statement.
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. For public companies, the statement of retained earnings
is often included in a statement of stockholders’ equity.
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.
18. What is the calculation for ROA? Explain what ROA measures.
Return on Assets = Net income / Average total assets. ROA measures how profitably a company
uses its assets.
© 2024 Pearson Education, Ltd. 1-3
