CHAPTER 1
Overview of Corporate Financial Reporting
SOLUTIONS TO DISCUSSION QUESTIONS
DQ1-1 Accounting, as an information system, provides economic information to
users to allow them to determine whether the entity is operating effectively
and efficiently. In addition, accounting facilitates the making of importan
decisions in the management of the entity, such as whether new assets
should be purchased or leased, or whether equity financing should be used
as opposed to debt financing.
DQ1-2 The owner’s legal liability is as follows for each form of business:
Proprietorship: The owner (or proprietor) is responsible for the debts of the
business. His or her personal assets are at risk in the event of legal action.
Partnership: The owners (or partners) are responsible for the debts of the
business. Their personal assets are at risk in event of legal action.
Corporation: The owners (or shareholders) are only responsible for the
debts of the corporation to the extent of their investment in the company’s
shares. Any debts in excess of this amount are not their responsibility.
, The taxation of income is as follows for each form of business:
Proprietorship: The income of a proprietorship is taxed in the hands of the
owner (i.e. the proprietor).
Partnership: The income of a partnership is taxed in the hands of the
owners (i.e. the partners).
DQ1-2 (Continued)
Corporation: The income of a corporation is taxed separately (i.e. the
corporation files its own tax return). Any income distributed to the
shareholders (i.e. dividends) is then taxed in the hands of the owners (i.e.
the shareholders).
DQ 1-3 A private corporation is one whose shares are held by a small number of
individuals. This makes the transfer of ownership more difficult, as the
shares do not trade on a public stock exchange. A public corporation has
shares held by a larger number of individuals or entities and these shares
are bought and sold on a public stock exchange (such as the Toronto Stock
Exchange).
DQ1-4 Shareholders – These users are interested in the performance of their
investment in the company. They will use the financial statements to
, evaluate how well management is handling their investment. Individual
shareholders may also use the financial statements in assessing whether
to continue to hold the shares, purchases more or sell the shares they
have.
Creditors (i.e. Financial Institutions) – These users are interested in
evaluating the company to decide whether to lend money to it. They will
use the statements to evaluate the risk that will be taken in making the
loan. This includes assessing the company’s ability to service the debt (i.e.
pay interest and repay principal).
Taxing Authorities – These users establish the rules for how taxable
income will be measured. They are interested in the fair measurement of
the financial performance of the company so that the appropriate tax will
be paid. Note, however, that income taxes are not paid based on the net
earnings reported in the financial statements; rather, income taxes are
based on taxable income. In preparing the tax return, the financial
statements’ net income is the starting point and is then adjusted to arrive
at taxable income.
DQ1-4 (Continued)
Financial Analysts – These users provide investment advice to their
customers. They are interested in evaluating the investment potential of
various companies. They will want to evaluate not only individual
companies, but also make comparisons between companies, likely in the
same industry.
(Note: there are other users discussed in the chapter that would be
equally acceptable answers to this question.)
, DQ1-5 Shareholders invest in the shares of a company. They may expect to
receive dividends, which are a distribution of past profits to shareholders.
They also expect to eventually sell their shares at a higher price than they
paid for them due to capital appreciation.
DQ1-6 Capital appreciation is an increase in the market value of the shares of a
company. Investors realize this type of return by purchasing shares in a
company, and then later selling the shares at a higher market price than
they had originally paid. Capital appreciation often results from a
company’s growth (i.e. increased revenues and increased profits).
DQ1-7 When creditors loan money to a company, they expect to receive their
money back. That is one cash stream, called return of principal. The
other cash stream is periodic interest that creditors receive for time they
have allowed the company to use their money.
DQ1-8 The three major types of activities in which all companies engage are
financing, investing, and operating activities.
Financing refers to the activity of obtaining funds for the company to
operate. Two primary sources of funds are owners and creditors. Some
typical financing activities are: short- and long-term borrowing, repayment
of debt, dividend payments, and the issuance of additional shares.
DQ1-8 (Continued)
Investing refers to the activity of using funds generated by financing activit
to acquire assets that will generate profits in the future. Investments inclu
the purchase of property, plant, and equipment and the purchase and sale
investments in other companies.
Overview of Corporate Financial Reporting
SOLUTIONS TO DISCUSSION QUESTIONS
DQ1-1 Accounting, as an information system, provides economic information to
users to allow them to determine whether the entity is operating effectively
and efficiently. In addition, accounting facilitates the making of importan
decisions in the management of the entity, such as whether new assets
should be purchased or leased, or whether equity financing should be used
as opposed to debt financing.
DQ1-2 The owner’s legal liability is as follows for each form of business:
Proprietorship: The owner (or proprietor) is responsible for the debts of the
business. His or her personal assets are at risk in the event of legal action.
Partnership: The owners (or partners) are responsible for the debts of the
business. Their personal assets are at risk in event of legal action.
Corporation: The owners (or shareholders) are only responsible for the
debts of the corporation to the extent of their investment in the company’s
shares. Any debts in excess of this amount are not their responsibility.
, The taxation of income is as follows for each form of business:
Proprietorship: The income of a proprietorship is taxed in the hands of the
owner (i.e. the proprietor).
Partnership: The income of a partnership is taxed in the hands of the
owners (i.e. the partners).
DQ1-2 (Continued)
Corporation: The income of a corporation is taxed separately (i.e. the
corporation files its own tax return). Any income distributed to the
shareholders (i.e. dividends) is then taxed in the hands of the owners (i.e.
the shareholders).
DQ 1-3 A private corporation is one whose shares are held by a small number of
individuals. This makes the transfer of ownership more difficult, as the
shares do not trade on a public stock exchange. A public corporation has
shares held by a larger number of individuals or entities and these shares
are bought and sold on a public stock exchange (such as the Toronto Stock
Exchange).
DQ1-4 Shareholders – These users are interested in the performance of their
investment in the company. They will use the financial statements to
, evaluate how well management is handling their investment. Individual
shareholders may also use the financial statements in assessing whether
to continue to hold the shares, purchases more or sell the shares they
have.
Creditors (i.e. Financial Institutions) – These users are interested in
evaluating the company to decide whether to lend money to it. They will
use the statements to evaluate the risk that will be taken in making the
loan. This includes assessing the company’s ability to service the debt (i.e.
pay interest and repay principal).
Taxing Authorities – These users establish the rules for how taxable
income will be measured. They are interested in the fair measurement of
the financial performance of the company so that the appropriate tax will
be paid. Note, however, that income taxes are not paid based on the net
earnings reported in the financial statements; rather, income taxes are
based on taxable income. In preparing the tax return, the financial
statements’ net income is the starting point and is then adjusted to arrive
at taxable income.
DQ1-4 (Continued)
Financial Analysts – These users provide investment advice to their
customers. They are interested in evaluating the investment potential of
various companies. They will want to evaluate not only individual
companies, but also make comparisons between companies, likely in the
same industry.
(Note: there are other users discussed in the chapter that would be
equally acceptable answers to this question.)
, DQ1-5 Shareholders invest in the shares of a company. They may expect to
receive dividends, which are a distribution of past profits to shareholders.
They also expect to eventually sell their shares at a higher price than they
paid for them due to capital appreciation.
DQ1-6 Capital appreciation is an increase in the market value of the shares of a
company. Investors realize this type of return by purchasing shares in a
company, and then later selling the shares at a higher market price than
they had originally paid. Capital appreciation often results from a
company’s growth (i.e. increased revenues and increased profits).
DQ1-7 When creditors loan money to a company, they expect to receive their
money back. That is one cash stream, called return of principal. The
other cash stream is periodic interest that creditors receive for time they
have allowed the company to use their money.
DQ1-8 The three major types of activities in which all companies engage are
financing, investing, and operating activities.
Financing refers to the activity of obtaining funds for the company to
operate. Two primary sources of funds are owners and creditors. Some
typical financing activities are: short- and long-term borrowing, repayment
of debt, dividend payments, and the issuance of additional shares.
DQ1-8 (Continued)
Investing refers to the activity of using funds generated by financing activit
to acquire assets that will generate profits in the future. Investments inclu
the purchase of property, plant, and equipment and the purchase and sale
investments in other companies.
