solution-manual-core-concepts-version-of-survey-of-accounting-1st-edition-raib

SOLUTIONS TO END OF CHAPTER MATERIAL QUESTIONS 1. The principal focus of financial accounting is to serve the needs of external decisionmakers. External decision makers need financial data about a business to make sound economic decisions. External parties, such as investors, lenders, and other groups (e.g., IRS) benefit from standardized financial reporting because the information in consistent from year to year and comparable from company to company. 2. The balance sheet equation is: Assets = Liabilities + Owners’ Equity. Assets represent all the items owned by a company. Assets have some future economic value (e.g., can be converted to cash, can be used to generate revenues). Many assets are tangible such as cash, a piece of equipment, or inventory. However, some assets do not have a physical representation such as accounts receivable, patents, and prepaid insurance. Liabilities represent all debts owed by a company to other companies or individuals. All that a company has (assets) minus all it owes (liabilities) is the worth of a company, known as owners’ equity. Equity can come from two sources. Equity can be contributed by owners; for example, an owner gives $10,000 of his personal money to the company in exchange for $10,000 equity in the company. Equity can also be generated by a profitable company. 3. The operating cycle is determined by the time period that exists between the use of cash for normal business operating activities and the receipt or collection of cash from the entity’s customers. The operating cycle for a homebuilder could may be three to six months, while the operating cycle for winery could be over a year or more. The operating cycle for a service firm could be a matter of days or weeks. The operating cycle effects how assets are classified on the Balance Sheet. Current assets, which are typically listed first in a balance sheet, include cash or any other asset that will be converted into cash, sold, or used up within the next year or the normal business operating cycle, whichever is longer. 4. The retained earnings account does not contain cash. It is a representation of how the equity in a business has increased because of profitable operations. Each year, the revenues earned by a company minus both the cost of doing business (expenses) and distributions to owners (dividends) is added to retained earnings. Therefore, retained earnings is the sum of yearly [revenues – expenses – dividends] since the company began. 5. The income statement is a “period-of-time” statement because the statement will reveal what revenues were earned and expenses incurred during a defined period (e.g., a month or a year). 6. Revenues are defined as increases in assets or decreases in liabilities that result from the profit-oriented activities of the business. Gross profit is the difference between the net revenues generated and the cost of goods sold during a particular period. Net income, which is computed by subtracting operating expenses from gross profit, is “bottom line” on the income statement. 7. Answer will vary depending on company chosen. 8. The common theme of the three financial reporting objectives of business entities is the need for the financial statements to give external parties the necessary information to make informed and rational decisions about economic events. Without this information, users of financial statements would not be able to make appropriate business and investment decisions. 9. Accounting information that is deemed to be reliable has the following three characteristics: verifiability, neutrality, and representational faithfulness. To be verifiable, more than one person should be able to validate accounting information. To be neutral, accounting information must be without bias, and to have representational faithfulness, accounting information must represent the business’ true economic resources, obligations, and transactions. 10. The principal reason that historical cost is used as the basis for assets is that it can be verified through documentation (bill of sale, etc.). Current values may differ depending on whose opinion is obtained. 11. Revenues should be both realized (assets exchanged for cash or a claim to cash) and earned (provided a product or service) before they are entered in the accounting records of an entity. 12. A general journal contains a chronological listing of transactions and how that transaction affected individual accounts. A general ledger contains individual accounts and all the changes made to the accounts by transactions.