CHAPTER 1
Introduction to Financial Statements
Learning Objectives
1. Identify the forms of business organization and the uses of accounting information.
2. Explain the three principal types of business activity.
3. Describe the four financial statements and how they are prepared.
*4. Explain the career opportunities in accounting.
ANSWERS TO QUESTIONS
1. The three basic forms of business organizations are (1) sole proprietorship, (2) partnership, and
(3) corporation.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
2. Advantages of a corporation are limited liability (stockholders not being personally liable for cor-
porate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a
corporation are increased taxation and government regulations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
3. Proprietorships and partnerships receive favorable tax treatment compared to corporations and are
easier to form than corporations. They are also owner controlled. Disadvantages of proprietorships
and partnerships are unlimited liability (proprietors/partners are personally liable for all debts) and
difficulty in obtaining financing compared to corporations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
4. Yes. Companies can choose one of the hybrid business forms, limited liability corporations
(LLCs) or subchapter S corporations, which combine the tax advantages of partnerships with the
limited liability of corporations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
5. Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay
taxes without receiving, using, or dispensing financial information. Accounting provides financial
information to interested users through the preparation and distribution of financial statements.
LO 1 BT: C Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting
6. Internal users are managers who plan, organize, and run a business. To assist management,
accounting provides timely internal reports. Examples include financial comparisons of operating
Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 1
, alternatives, projections of income from new sales campaigns, forecasts of cash needs for the
next year, and financial statements.
LO 1 BT: C Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting
7. External u users u are u those u outside u the u business u who u have u either u a u present u or
u potential u direct u financial uinterest u (investors uand u creditors) uor uan u indirect ufinancial
uinterest u(taxing uauthorities, uregu- u latory uagencies, ulabor uunions, ucustomers, uand
ueconomic uplanners).
LO u1 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
8. u The u four u most u common u types u of u data u analytics u and u the u basic u question u each
u addresses u are: u Descriptive u (What u happened?), u Diagnostic u (Why u did u it u happen?),
u Predictive u (What u is u likely u to u happen?), uand uPrescriptive u(What ushould uwe udo uabout
uit?).
LO u1 u u BT: u K u uDifficulty: uE u uTOT: u 2 umin. u u AACSB: u nowledge u u AICPA u u AC: u Measurement uAnalysis uand
uInterpretation
Questions uChapter u1 u(Continued)
9. u The u three u types u of u business u activities u are u financing u activities, u investing u activities, u and
u operating activities. u Financing u activities u include u borrowing u money u and u selling
u
u shares u of u stock. u Investing u activities u include u the u purchase u and u sale u of u property,
u plant, u and u equipment. u Operating u activities u include uselling ugoods, uperforming uservices,
uand upurchasing uinventory.
LO u2 u uBT: u C u uDifficulty: uM u uTOT: u2 umin. u u AACSB: uKnowledge u uAICPA uAC: uReporting
10. u Income ustatement. (d) Balance usheet.
u (a) (b) Balance usheet. (e) Balance usheet.
(c) Income ustatement. (f) Balance usheet.
LO u3 u uBT: u K u uDifficulty: uM u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
11. When u a u company u pays u dividends, u it u reduces u the u amount u of u assets u available u to
u pay u creditors. u Therefore, u banks u and u other u creditors u monitor u dividend u payments u to
u ensure u they u do u not u put u a u company’s uability uto umake udebt upayments uat urisk.
LO u3 u u BT: u C u uDifficulty: uM u u TOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uMeasurement u Anallysis uand
uInterpretation
12. Yes. u Net u income u does u appear u on u the u income u statement—it u is u the u result u of
u subtracting u expenses u from urevenues. uIn uaddition, unet u income u appears uin uthe uretained
u earnings u statement—it u is ushown u as u an uaddition u to u the ubeginning-of-period u retained
u earnings. uIndirectly, u the u net u income u of u a u company u is ualso uincluded u in uthe ubalance
usheet. uIt u is uincluded uin uthe uretained uearnings uaccount uwhich uappears u in uthe
ustockholders’ uequity usection uof uthe ubalance usheet.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
13. The u primary u purpose u of u the u statement u of u cash u flows u is u to u provide u financial
2 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only)
, u information u about u the u cash ureceipts uand ucash upayments uof ua ubusiness ufor ua uspecific
uperiod uof utime.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 3
, 14. The u three u categories u of u the u statement u of u cash u flows u are u operating u activities,
u investing u activities, u and u financing u activities. u The u categories u were u chosen u because
u they u represent u the u three u principal u types uof ubusiness uactivities.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
15. Retained uearnings uis uthe unet uincome uretained uin ua ucorporation. uRetained uearnings uis
uincreased u by u net uincome uand uis udecreased uby udividends uand ua unet uloss.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
16. The ubasic uaccounting uequation uis uAssets u= uLiabilities u+ uStockholders’ uEquity.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
17. (a) u Assets uare uresources uowned uby ua ubusiness. uLiabilities uare uamounts uowed uto ucreditors.
uPut umore u simply, u liabilities uare u existing u debts uand uobligations. u Stockholders’ uequity uis
uthe u ownership u claim u on unet uassets.
(b) The u u items u u that u u affect u u stockholders’ u u equity u u are u u issuance u u of u u common
u u stock u u and u u the u components uof u retained uearnings u (dividends, u revenues, uand
uexpenses).
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 2 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
18. The uliabilities uare u(b) uAccounts upayable uand u(g) uSalaries uand uwages upayable.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
19. (a) Net u income u from u the u income u statement u is u reported u as u an u increase u to u retained
u earnings u on u the uretained uearnings ustatement.
(b) The uending uamount uon u the uretained uearnings ustatement u is u reported u as uthe
u retained u earnings u amount uon uthe ubalance usheet.
(c) The u ending u amount u on u the u statement u of u cash u flows u is u reported u as u the u cash
u amount u on u the u balance usheet.
LO u3 u uBT: u C u uDifficulty: uM u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
20. The u purpose u of u the u management u discussion u and u analysis u section u is u to u provide
u management’s u views uon u its u ability uto u pay ushort-term uobligations, u its uability uto ufund
u operations uand u expansion, u and u its uresults uof uoperations. uThe uMD&A usection uis ua
urequired upart uof uthe uannual ureport.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
21. An u unqualified u opinion u shows u that, u in u the u opinion u of u an u independent u auditor, u the
u financial u state u- u ments u have u been u presented u fairly, u in u conformity u with u generally
u accepted u accounting u principles. u This u gives u investors u more u confidence u that u they u can
u rely u on u the u figures u reported u in u the u financial u statements.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
4 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only)
Introduction to Financial Statements
Learning Objectives
1. Identify the forms of business organization and the uses of accounting information.
2. Explain the three principal types of business activity.
3. Describe the four financial statements and how they are prepared.
*4. Explain the career opportunities in accounting.
ANSWERS TO QUESTIONS
1. The three basic forms of business organizations are (1) sole proprietorship, (2) partnership, and
(3) corporation.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
2. Advantages of a corporation are limited liability (stockholders not being personally liable for cor-
porate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a
corporation are increased taxation and government regulations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
3. Proprietorships and partnerships receive favorable tax treatment compared to corporations and are
easier to form than corporations. They are also owner controlled. Disadvantages of proprietorships
and partnerships are unlimited liability (proprietors/partners are personally liable for all debts) and
difficulty in obtaining financing compared to corporations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
4. Yes. Companies can choose one of the hybrid business forms, limited liability corporations
(LLCs) or subchapter S corporations, which combine the tax advantages of partnerships with the
limited liability of corporations.
LO 1 BT: K Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA BC: Governance Perspective
5. Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay
taxes without receiving, using, or dispensing financial information. Accounting provides financial
information to interested users through the preparation and distribution of financial statements.
LO 1 BT: C Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting
6. Internal users are managers who plan, organize, and run a business. To assist management,
accounting provides timely internal reports. Examples include financial comparisons of operating
Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 1
, alternatives, projections of income from new sales campaigns, forecasts of cash needs for the
next year, and financial statements.
LO 1 BT: C Difficulty: E TOT: 1 min. AACSB: Knowledge AICPA AC: Reporting
7. External u users u are u those u outside u the u business u who u have u either u a u present u or
u potential u direct u financial uinterest u (investors uand u creditors) uor uan u indirect ufinancial
uinterest u(taxing uauthorities, uregu- u latory uagencies, ulabor uunions, ucustomers, uand
ueconomic uplanners).
LO u1 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
8. u The u four u most u common u types u of u data u analytics u and u the u basic u question u each
u addresses u are: u Descriptive u (What u happened?), u Diagnostic u (Why u did u it u happen?),
u Predictive u (What u is u likely u to u happen?), uand uPrescriptive u(What ushould uwe udo uabout
uit?).
LO u1 u u BT: u K u uDifficulty: uE u uTOT: u 2 umin. u u AACSB: u nowledge u u AICPA u u AC: u Measurement uAnalysis uand
uInterpretation
Questions uChapter u1 u(Continued)
9. u The u three u types u of u business u activities u are u financing u activities, u investing u activities, u and
u operating activities. u Financing u activities u include u borrowing u money u and u selling
u
u shares u of u stock. u Investing u activities u include u the u purchase u and u sale u of u property,
u plant, u and u equipment. u Operating u activities u include uselling ugoods, uperforming uservices,
uand upurchasing uinventory.
LO u2 u uBT: u C u uDifficulty: uM u uTOT: u2 umin. u u AACSB: uKnowledge u uAICPA uAC: uReporting
10. u Income ustatement. (d) Balance usheet.
u (a) (b) Balance usheet. (e) Balance usheet.
(c) Income ustatement. (f) Balance usheet.
LO u3 u uBT: u K u uDifficulty: uM u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
11. When u a u company u pays u dividends, u it u reduces u the u amount u of u assets u available u to
u pay u creditors. u Therefore, u banks u and u other u creditors u monitor u dividend u payments u to
u ensure u they u do u not u put u a u company’s uability uto umake udebt upayments uat urisk.
LO u3 u u BT: u C u uDifficulty: uM u u TOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uMeasurement u Anallysis uand
uInterpretation
12. Yes. u Net u income u does u appear u on u the u income u statement—it u is u the u result u of
u subtracting u expenses u from urevenues. uIn uaddition, unet u income u appears uin uthe uretained
u earnings u statement—it u is ushown u as u an uaddition u to u the ubeginning-of-period u retained
u earnings. uIndirectly, u the u net u income u of u a u company u is ualso uincluded u in uthe ubalance
usheet. uIt u is uincluded uin uthe uretained uearnings uaccount uwhich uappears u in uthe
ustockholders’ uequity usection uof uthe ubalance usheet.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
13. The u primary u purpose u of u the u statement u of u cash u flows u is u to u provide u financial
2 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only)
, u information u about u the u cash ureceipts uand ucash upayments uof ua ubusiness ufor ua uspecific
uperiod uof utime.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only) 3
, 14. The u three u categories u of u the u statement u of u cash u flows u are u operating u activities,
u investing u activities, u and u financing u activities. u The u categories u were u chosen u because
u they u represent u the u three u principal u types uof ubusiness uactivities.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
15. Retained uearnings uis uthe unet uincome uretained uin ua ucorporation. uRetained uearnings uis
uincreased u by u net uincome uand uis udecreased uby udividends uand ua unet uloss.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
16. The ubasic uaccounting uequation uis uAssets u= uLiabilities u+ uStockholders’ uEquity.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
17. (a) u Assets uare uresources uowned uby ua ubusiness. uLiabilities uare uamounts uowed uto ucreditors.
uPut umore u simply, u liabilities uare u existing u debts uand uobligations. u Stockholders’ uequity uis
uthe u ownership u claim u on unet uassets.
(b) The u u items u u that u u affect u u stockholders’ u u equity u u are u u issuance u u of u u common
u u stock u u and u u the u components uof u retained uearnings u (dividends, u revenues, uand
uexpenses).
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 2 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
18. The uliabilities uare u(b) uAccounts upayable uand u(g) uSalaries uand uwages upayable.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u1 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
19. (a) Net u income u from u the u income u statement u is u reported u as u an u increase u to u retained
u earnings u on u the uretained uearnings ustatement.
(b) The uending uamount uon u the uretained uearnings ustatement u is u reported u as uthe
u retained u earnings u amount uon uthe ubalance usheet.
(c) The u ending u amount u on u the u statement u of u cash u flows u is u reported u as u the u cash
u amount u on u the u balance usheet.
LO u3 u uBT: u C u uDifficulty: uM u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
20. The u purpose u of u the u management u discussion u and u analysis u section u is u to u provide
u management’s u views uon u its u ability uto u pay ushort-term uobligations, u its uability uto ufund
u operations uand u expansion, u and u its uresults uof uoperations. uThe uMD&A usection uis ua
urequired upart uof uthe uannual ureport.
LO u3 u uBT: u K u uDifficulty: uE u uTOT: u 1 umin. u u AACSB: u Knowledge u u AICPA uAC: uReporting
21. An u unqualified u opinion u shows u that, u in u the u opinion u of u an u independent u auditor, u the
u financial u state u- u ments u have u been u presented u fairly, u in u conformity u with u generally
u accepted u accounting u principles. u This u gives u investors u more u confidence u that u they u can
u rely u on u the u figures u reported u in u the u financial u statements.
LO u3 u uBT: u C u uDifficulty: uE u uTOT: u2 umin. u u AACSB: u Knowledge u uAICPA uAC: uReporting
4 Copyright © John Wiley & Sons, Inc. Solutions Manual (For Instructor Use Only)
