Chapter 1 - A Framework for Financial Accounting
Chapter 1
A Framework for Financial Accounting
REVIEW QUESTIONS
Question 1-1 (LO 1-1)
Accounting is the language of business. Whereas a basic math class might involve adding,
subtracting, and solving for unknown variables, accounting involves learning to measure business
transactions and communicating those measurements in a format that is generally understood by
decision makers.
Question 1-2 (LO 1-1)
Those interested in making decisions about a company include investors, creditors, customers,
suppliers, managers, employees, competitors, regulators, tax authorities, and local communities.
Question 1-3 (LO 1-1)
Financial accounting seeks to measure business activities of a company and to communicate
those measurements to external parties for decision-making purposes. The two primary external, or
outside the firm, users of financial accounting information are investors and creditors. Managerial
accounting deals with the methods accountants use to provide information to an organization’s
internal users, that is, its own managers.
Question 1-4 (LO 1-1)
The two primary functions of financial accounting are to measure business activities of a
company and to communicate information about those activities to investors and creditors for
decision-making purposes.
Question 1-5 (LO 1-2)
The three basic business activities are financing, investing, and operating activities. Financing
activities are transactions that raise cash needed to operate the business. Investing activities typically
include the purchase or disposal of long-term resources such as land, buildings, equipment, and
machinery. Operating activities include the primary operations of the company, providing products
and services to customers and the associated costs of doing so, like utilities, taxes, advertising,
wages, rent, and maintenance.
Question 1-6 (LO 1-2)
Typical financing activities would include selling stock and paying dividends to investors, as
well as borrowing and repaying debt to creditors.
Question 1-7 (LO 1-2)
Typical investing activities would include the purchase or disposal of land, casino buildings,
hotels, gaming tables, chairs, cleaning equipment, and food preparation machines.
©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution
permitted without the prior written consent of McGraw-Hill Education.
Solutions Manual, Chapter 1 1-1
,Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-8 (LO 1-2)
Typical operating activities would include the sale of software and consulting services, as well as
costs related to salaries, research, utilities, advertising, rent, and taxes.
Question 1-9 (LO 1-2)
The three major legal forms of business organizations include sole proprietorship, partnership,
and corporation? A corporation is chosen by most of the largest companies in the United States.
Question 1-10 (LO 1-2)
Assets: Resources owned.
Liabilities: Amounts owed.
Stockholders’ equity: Owners’ claims to resources.
Dividends: Distributions to stockholders.
Revenues: Sales of products or services to customers.
Expenses: Costs of selling products or services.
Question 1-11 (LO 1-2)
The major advantage of a corporation is limited liability. Stockholders of a corporation are not
held personally responsible for the financial obligations of the corporation. Owners of sole
proprietorships or partnerships remain personally liable for activities of the business. Corporations
have the disadvantages of double taxation compared to sole proprietorships and partnerships. Sole
proprietorship and partnership forms of business is that income is taxed only once. However, there
could be other tax advantages for certain types of corporations, such as a lower overall tax rate.
Question 1-12 (LO 1-3)
1. Income statement: Reports the company’s revenues and expenses during an interval of time.
If revenues exceed expenses, then the company reports net income. If expenses exceed
revenues, then the company reports a net loss.
2. Statement of stockholders’ equity: Summarizes the changes in stockholders’ equity from net
income, dividends, and stock issuances during an interval of time.
3. Balance sheet: Presents the financial position of the company on a particular date. It shows
that assets equal liabilities plus stockholders’ equity.
4. Statement of cash flows: Cash activities related to operating, investing, and financing
activities during an interval of time.
Question 1-13 (LO 1-3)
Balances of accounts reported in the income statement, statement of stockholders’ equity, and
statement of cash flows reflect activity from the beginning of the period through the end of the
period. Balances of accounts reported in the balance sheet reflect the financial position of the
company as of a single date, the end of the period.
©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further
distribution permitted without the prior written consent of McGraw-Hill Education
1-2 Financial Accounting, 5e
, Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-14 (LO 1-3)
Basic revenues would include sale of products (such as toys, dolls, and games) and services (such
as theme park tickets). Expenses include cost of merchandise sold, employee salaries, utilities,
advertising, taxes, interest, and legal fees.
Question 1-15 (LO 1-3)
The accounting equation is: Assets = Liabilities + Stockholders’ Equity. The format of the
balance sheet follows the accounting equation.
Question 1-16 (LO 1-3)
Assets would include items such as merchandise inventory, office supplies, buildings, land,
trucks, and equipment. Liabilities would include items such as amounts owed to employees,
suppliers, taxing authorities, and lenders.
Question 1-17 (LO 1-3)
Retained earnings represent the cumulative amount of net income earned over the life of the
company that has not been distributed to stockholders as dividends. Net income is shown in the
income statement and retained earnings are reported in the balance sheet. Thus, retained earnings
represent a balance sheet account which reflects the cumulative result of income statements over the
life of the company (less any dividends).
Question 1-18 (LO 1-3)
The statement of cash flows reports operating, investing, and financing cash flows. Examples of
each include:
Operating – selling merchandise, paying employee salaries, and paying for advertisement.
Investing – purchasing land and buildings to open new factories.
Financing – Borrowing from lenders or issuing stock to owners to obtain funds necessary to
expand operations.
Question 1-19 (LO 1-3)
Two other important sources of information are the (1) management discussion and analysis of
the company’s activities and (2) note disclosures to the financial statements.
Question 1-20 (LO 1-4)
Successful companies use their resources efficiently to sell products and services for a profit.
Unsuccessful companies either offer lower-quality products and services or do not efficiently keep
their costs low. When a company is unprofitable, investors will neither invest in nor lend to the firm.
Without these sources of financing, eventually the company will fail. When a company is able to
make a profit, investors and creditors are willing to transfer their resources to it, and the company
will expand its profitable operations even further. Investors and creditors rely heavily on financial
accounting information in making investment and lending decisions.
©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution
permitted without the prior written consent of McGraw-Hill Education.
Solutions Manual, Chapter 1 1-3
, Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-21 (LO 1-5)
GAAP refers to Generally Accepted Accounting Principles, or the rules of financial accounting.
The fact that all companies use the same rules is critical to financial statement users, because it
allows them to accurately compare financial information among companies when they are making
decisions about where to lend or invest their resources.
Question 1-22 (LO 1-5)
The Financial Accounting Standards Board (FASB) is primarily responsible for the establishment
of GAAP in the United States. The International Accounting Standards Board (IASB) serves this
function on an international basis.
Question 1-23 (LO 1-5)
U.S. GAAP refers to the set of accounting standards being developed in the United States by the
Financial Accounting Standards Board (FASB). IFRS (International Financial Reporting Standards)
refers to the set of accounting standards being developed by the International Accounting Standards
Board (IASB). The IASB promotes the use of IFRS around the world. Today, the IASB and FASB
work closely in an effort to converge the two sets of accounting standards.
Question 1-24 (LO 1-5)
The 1933 Securities Act and the 1934 Securities Exchange Act were designed to restore investor
confidence in financial accounting following the stock market crash in 1929 and the ensuing Great
Depression. The SEC has the power to require companies with publicly traded securities to prepare
periodic financial statements for distribution to investors and creditors.
Question 1-25 (LO 1-5)
The role of auditors is to help ensure that management has in fact appropriately applied GAAP in
preparing the company’s financial statements. They are hired by a company as an independent party
to express a professional opinion of the conformity of that company’s financial statements with
GAAP. Auditors play a major role in investors’ and creditors’ decisions by adding credibility to the
financial statements.
Question 1-26 (LO 1-5)
The three objectives of financial reporting are providing information that:
1. is useful to investors and creditors in making decisions.
2. helps to predict cash flows.
3. tells about economic resources, claims to resources, and changes in resources and claims.
©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further
distribution permitted without the prior written consent of McGraw-Hill Education
1-4 Financial Accounting, 5e
Chapter 1
A Framework for Financial Accounting
REVIEW QUESTIONS
Question 1-1 (LO 1-1)
Accounting is the language of business. Whereas a basic math class might involve adding,
subtracting, and solving for unknown variables, accounting involves learning to measure business
transactions and communicating those measurements in a format that is generally understood by
decision makers.
Question 1-2 (LO 1-1)
Those interested in making decisions about a company include investors, creditors, customers,
suppliers, managers, employees, competitors, regulators, tax authorities, and local communities.
Question 1-3 (LO 1-1)
Financial accounting seeks to measure business activities of a company and to communicate
those measurements to external parties for decision-making purposes. The two primary external, or
outside the firm, users of financial accounting information are investors and creditors. Managerial
accounting deals with the methods accountants use to provide information to an organization’s
internal users, that is, its own managers.
Question 1-4 (LO 1-1)
The two primary functions of financial accounting are to measure business activities of a
company and to communicate information about those activities to investors and creditors for
decision-making purposes.
Question 1-5 (LO 1-2)
The three basic business activities are financing, investing, and operating activities. Financing
activities are transactions that raise cash needed to operate the business. Investing activities typically
include the purchase or disposal of long-term resources such as land, buildings, equipment, and
machinery. Operating activities include the primary operations of the company, providing products
and services to customers and the associated costs of doing so, like utilities, taxes, advertising,
wages, rent, and maintenance.
Question 1-6 (LO 1-2)
Typical financing activities would include selling stock and paying dividends to investors, as
well as borrowing and repaying debt to creditors.
Question 1-7 (LO 1-2)
Typical investing activities would include the purchase or disposal of land, casino buildings,
hotels, gaming tables, chairs, cleaning equipment, and food preparation machines.
©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution
permitted without the prior written consent of McGraw-Hill Education.
Solutions Manual, Chapter 1 1-1
,Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-8 (LO 1-2)
Typical operating activities would include the sale of software and consulting services, as well as
costs related to salaries, research, utilities, advertising, rent, and taxes.
Question 1-9 (LO 1-2)
The three major legal forms of business organizations include sole proprietorship, partnership,
and corporation? A corporation is chosen by most of the largest companies in the United States.
Question 1-10 (LO 1-2)
Assets: Resources owned.
Liabilities: Amounts owed.
Stockholders’ equity: Owners’ claims to resources.
Dividends: Distributions to stockholders.
Revenues: Sales of products or services to customers.
Expenses: Costs of selling products or services.
Question 1-11 (LO 1-2)
The major advantage of a corporation is limited liability. Stockholders of a corporation are not
held personally responsible for the financial obligations of the corporation. Owners of sole
proprietorships or partnerships remain personally liable for activities of the business. Corporations
have the disadvantages of double taxation compared to sole proprietorships and partnerships. Sole
proprietorship and partnership forms of business is that income is taxed only once. However, there
could be other tax advantages for certain types of corporations, such as a lower overall tax rate.
Question 1-12 (LO 1-3)
1. Income statement: Reports the company’s revenues and expenses during an interval of time.
If revenues exceed expenses, then the company reports net income. If expenses exceed
revenues, then the company reports a net loss.
2. Statement of stockholders’ equity: Summarizes the changes in stockholders’ equity from net
income, dividends, and stock issuances during an interval of time.
3. Balance sheet: Presents the financial position of the company on a particular date. It shows
that assets equal liabilities plus stockholders’ equity.
4. Statement of cash flows: Cash activities related to operating, investing, and financing
activities during an interval of time.
Question 1-13 (LO 1-3)
Balances of accounts reported in the income statement, statement of stockholders’ equity, and
statement of cash flows reflect activity from the beginning of the period through the end of the
period. Balances of accounts reported in the balance sheet reflect the financial position of the
company as of a single date, the end of the period.
©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further
distribution permitted without the prior written consent of McGraw-Hill Education
1-2 Financial Accounting, 5e
, Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-14 (LO 1-3)
Basic revenues would include sale of products (such as toys, dolls, and games) and services (such
as theme park tickets). Expenses include cost of merchandise sold, employee salaries, utilities,
advertising, taxes, interest, and legal fees.
Question 1-15 (LO 1-3)
The accounting equation is: Assets = Liabilities + Stockholders’ Equity. The format of the
balance sheet follows the accounting equation.
Question 1-16 (LO 1-3)
Assets would include items such as merchandise inventory, office supplies, buildings, land,
trucks, and equipment. Liabilities would include items such as amounts owed to employees,
suppliers, taxing authorities, and lenders.
Question 1-17 (LO 1-3)
Retained earnings represent the cumulative amount of net income earned over the life of the
company that has not been distributed to stockholders as dividends. Net income is shown in the
income statement and retained earnings are reported in the balance sheet. Thus, retained earnings
represent a balance sheet account which reflects the cumulative result of income statements over the
life of the company (less any dividends).
Question 1-18 (LO 1-3)
The statement of cash flows reports operating, investing, and financing cash flows. Examples of
each include:
Operating – selling merchandise, paying employee salaries, and paying for advertisement.
Investing – purchasing land and buildings to open new factories.
Financing – Borrowing from lenders or issuing stock to owners to obtain funds necessary to
expand operations.
Question 1-19 (LO 1-3)
Two other important sources of information are the (1) management discussion and analysis of
the company’s activities and (2) note disclosures to the financial statements.
Question 1-20 (LO 1-4)
Successful companies use their resources efficiently to sell products and services for a profit.
Unsuccessful companies either offer lower-quality products and services or do not efficiently keep
their costs low. When a company is unprofitable, investors will neither invest in nor lend to the firm.
Without these sources of financing, eventually the company will fail. When a company is able to
make a profit, investors and creditors are willing to transfer their resources to it, and the company
will expand its profitable operations even further. Investors and creditors rely heavily on financial
accounting information in making investment and lending decisions.
©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution
permitted without the prior written consent of McGraw-Hill Education.
Solutions Manual, Chapter 1 1-3
, Chapter 1 - A Framework for Financial Accounting
Answers to Review Questions (continued)
Question 1-21 (LO 1-5)
GAAP refers to Generally Accepted Accounting Principles, or the rules of financial accounting.
The fact that all companies use the same rules is critical to financial statement users, because it
allows them to accurately compare financial information among companies when they are making
decisions about where to lend or invest their resources.
Question 1-22 (LO 1-5)
The Financial Accounting Standards Board (FASB) is primarily responsible for the establishment
of GAAP in the United States. The International Accounting Standards Board (IASB) serves this
function on an international basis.
Question 1-23 (LO 1-5)
U.S. GAAP refers to the set of accounting standards being developed in the United States by the
Financial Accounting Standards Board (FASB). IFRS (International Financial Reporting Standards)
refers to the set of accounting standards being developed by the International Accounting Standards
Board (IASB). The IASB promotes the use of IFRS around the world. Today, the IASB and FASB
work closely in an effort to converge the two sets of accounting standards.
Question 1-24 (LO 1-5)
The 1933 Securities Act and the 1934 Securities Exchange Act were designed to restore investor
confidence in financial accounting following the stock market crash in 1929 and the ensuing Great
Depression. The SEC has the power to require companies with publicly traded securities to prepare
periodic financial statements for distribution to investors and creditors.
Question 1-25 (LO 1-5)
The role of auditors is to help ensure that management has in fact appropriately applied GAAP in
preparing the company’s financial statements. They are hired by a company as an independent party
to express a professional opinion of the conformity of that company’s financial statements with
GAAP. Auditors play a major role in investors’ and creditors’ decisions by adding credibility to the
financial statements.
Question 1-26 (LO 1-5)
The three objectives of financial reporting are providing information that:
1. is useful to investors and creditors in making decisions.
2. helps to predict cash flows.
3. tells about economic resources, claims to resources, and changes in resources and claims.
©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further
distribution permitted without the prior written consent of McGraw-Hill Education
1-4 Financial Accounting, 5e
