Accounting 2000

Module 1 Class Notes – ANSWER KEY

Chapter 1

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.

Forms of business organization:

Name/Definition Advantages Disadvantages

1. Simple to establish Personal liability

Sole Proprietorship Control

Tax Advantages

2. Simple to establish Personal liability

Partnership Broader skills and

(2 or more) resources

Tax advantages

3. Easy to transfer ownership Taxes

Corporation Easy to raise capital

“unlimited life”
- Our focus No personal liability

The purpose of financial information is to provide inputs for decision making.

Accounting is the information system that identifies, records and communicates economic
events of an organization to interested users.

Users of accounting information

Type Examples How use financial information

1. Internal Managers, Internal reports – plan, organize
Supervisors, and run a business
Company Officials
2. External Investors, Creditors, Decisions to buy or sell stock or
Regulators loan company money

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Ethics in Financial Reporting

Effective financial reporting depends on sound _ethical behavior_.

Financial scandals led Congress to the pass the Sarbanes- Oxley Act in 2002. (SOX)

Key Provisions:
1. Top management must certify accuracy of financial reports
2. Severe penalties for fraud
3. Increased auditor duties

Three types of business activities and examples of each.

Business Activity Definition Examples

Financing Raising money *Borrow money from
creditor

*Issue (sell) shares of stock

to investors
Investing Purchase of resources Resources owned and used
needed to operate by a business (computers,
equipment, delivery trucks)
Operating Day to day operations Shoe store selling shoes,
dentist cleaning teeth, lawn
care company mowing
lawns.

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Companies prepare 4 financial statements to communicate financial information to users:

Name Definition Components Date

Income Statement Reports revenue Revenues Time span

and expenses over - Expenses (month, quarter or
a period of time = Net Income year)

Retained Earnings R/E is the net Beginning R/E Time span

Statement income retained in +Net Income (same as income
the business. -Dividends statement)
Statement reports = Ending R/E
changes.
Balance Sheet Reports assets and Accounting Date – point in time
claims to assets at a Equation
specific point in Last day of time
time. Assets = Liabilities span
+ Stockholders’
Equity

Statement of Cash Shows sources and 3 sections Time span

Flows uses of cash (same as income
-Financing statement)
-Investing
-Operating

Interrelationship of Financial Statements:

Review the financial statements and draw arrows to show the interrelationships of the financial
statements (see illustrations 1-9, page 16)

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Module 1 Class Notes – ANSWER KEY

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 Accounting 2000
Module 1 Class Notes – ANSWER KEY

Definitions

Definition Examples
Assets Resources owned by a Cash, Accounts
business Receivable, Inventory,
Supplies, Property, Plant
and Equipment
Liabilities Amounts owed to Accounts Payable, Notes
creditors/suppliers Payable, Bonds Payable
Stockholders’ Equity Owner’s claims to assets Common Stock
Retained Earnings
Common Stock Amounts received from issuing
(selling) shares of stock
Retained Earnings Net income retained in the
business
Dividends Cash payments to stockholders

Revenues Amounts earned from sale of Sales Revenue

products or services performed Service Revenue
Interest Revenue
Expenses Cost of assets consumed or Rent Expense
services used Utilities Expense
Interest Expense
Cost of Goods Sold
Net Income Revenues > Expenses
Net Loss Expenses > Revenues

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Module 1 Class Notes – ANSWER KEY

State the basic accounting equation:

Assets = Liabilities + Stockholders’ Equity

Components of the Annual Report

Component Definition
1. Financials See page 3
Statements
2. Management Management’s discussion of trends, ability to pay, debts and
Discussion and Analysis results of operations (MD&A)
[Link] to the Financial Clarify the financial statements and gives additional details.
Statements
[Link]’s Report Auditor’s opinion as to the fairness of the financial statements

Financial statements should be prepared in the following order

1. Income Statement

2. Retained Earnings Statement

3. Balance Sheet

(Statement of Cash Flow not covered in this class)

Other Definitions:

Accounts Name Classification/Type Financial Statement

Ex. Notes Payable Liability Balance Sheet

Supplies Asset Balance Sheet

Investments Asset Balance Sheet

Service Revenue Revenue Income Statement

Inventory Asset Balance Sheet

Accounts Receivable Asset Balance Sheet

Cost of Goods Sold Expense Income Statement

Utilities Expenses Expense Income Statement

Accounts Payable Liability Balance Sheet

Wages Payable Liability Balance Sheet

Unearned Service Liability Balance Sheet

Revenue

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 Accounting 2000
Module 1 Class Notes – ANSWER KEY

Class Problems

BE1-2 Match each of the following types of evaluation with one of the listed users of accounting information.
1. Trying to determine whether the company complied with tax laws.
2. Trying to determine whether the company can pay its obligations.
3. Trying to determine whether a marketing proposal will be cost effective.
4. Trying to determine whether the company's net income will result in a stock price increase.
5. Trying to determine whether the company should employ debt or equity financing.
a. Investors in common stock. – 4
b. Marketing managers. – 3
c. Creditors. – 2
d. Chief Financial Officer. - 5
e. Internal Revenue Service. - 1

BE1-6 Eskimo Pie Corporation markets a broad range of frozen treats, including its famous Eskimo Pie ice cream bars. The
following items were taken from a recent income statement and balance sheet. In each case, identify whether the item
would appear on the balance sheet (BS) or income statement (IS).
a. Income tax expense. - IS
b. Inventories. -BS
c. Accounts payable. -BS
d. Retained earnings. - BS
e. Property, plant, and equipment. - BS
f. Net sales. (Revenue) - IS
g. Cost of goods sold. - IS
h. Common stock. -BS
i. Receivables. - BS
j. Interest expense. -IS

P1-3B Shaw’s Garden was started on May 1 with an investment of $45,000 cash. Following are the assets and liabilities of the
company on May 31, 2017, and the revenues and expenses for the month of May, its first month of operations.
Accounts receivable $ 6,200 Notes payable $28,000
Service revenue 10,400 Salaries and wages expense 2,000
Advertising expense 800 Equipment 56,000
Accounts payable 2,400 Maintenance and repairs expense 2,900
Cash 15,800 Insurance expense 400
No additional common stock was issued in May, but a dividend of $1,700 in cash was paid.
Instructions
(a) Prepare an income statement and a retained earnings statement for the month of May and a balance sheet at May 31,
2017.

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Shaw’s Garden
Income Statement
For the Month Ended, May 31, 2017
Revenues:
Service Revenue $10,400
Expenses
Maintenance and Repairs Expense 2,900
Salary and Wage Expense 2,000
Advertising Expense 800
Insurance Expense 400
Total Expenses 6,100
Net Income $4,300

Shaw’s Garden
Retained Earnings Statement
For the Month Ended, May 31, 2017
Retained Earnings, May 1st 0
+ Net Income 4,300
-Dividends (1,700)
Retained Earnings, May 31st $2,600

Shaw’s Garden
Balance Sheet
May 31, 2017
Assets
Cash $15,800
Accounts Receivable 6,200
Equipment 56,000
Total Assets $78,000

Liabilities
Notes Payable $28,000
Accounts Payable 2,400
Total Liabilities 30,400

Stockholders’ Equity
Common Stock 45,000
Retained Earnings 2,600
Total Stockholders’ Equity 47,600
Total Liabilities and Stockholders’ Equity $78,000

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Chapter 2

Learning Objectives:
1. Identify the sections of a classified balance sheet.
2. Use ratios to evaluate a company’s profitability, liquidity, and solvency.
3. Discuss financial reporting concepts.

The Classified Balance Sheet

• Reports the __assets_____, ___liabilities____, and ___stockholders’ equity_____
at a specific point in time.
• Groups together similar assets and similar liabilities, using standard classifications

FRANKLIN CORPORATION
Balance Sheet
October 31, 2017
Assets
Current assets
Cash $ 6,600
Debt investments 2,000
Accounts receivable 7,000
Notes receivable 1,000
Inventory 3,000
Supplies 2,100
Prepaid insurance 400
Total current assets $22,100
Long-term investments
Stock investments 5,200
Investment in real estate 2,000 7,200
Property, plant, and equipment
Land 10,000
Equipment $24,000
Less: Accumulated depreciation—equipment 5,000 19,000 29,000
Intangible assets
Patents 3,100
Total assets $61,400

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Liabilities and Stockholders' Equity

Current liabilities
Notes payable $11,000
Accounts payable 2,100
Unearned sales revenue 900
Salaries and wages payable 1,600
Interest payable 450
Total current liabilities $16,050
Long-term liabilities
Mortgage payable 10,000
Notes payable 1,300
Total long-term liabilities 11,300
Total liabilities 27,350
Stockholders' equity
Common stock 14,000
Retained earnings 20,050
Total stockholders' equity 34,050
Total liabilities and stockholders' equity $61,400

Current Assets

• Assets that a company expects to ___convert to cash__ or __use up__ within one
year or the operating cycle, whichever is longer.
• Operating cycle is the average time it takes from the _purchase of inventory___ to the
__collection of cash__ from customers.
• For most businesses, the cycle is less than a year so a one-year cutoff is used.
• Current assets are listed in the order in which __they are converted to cash __Known
as liquidity__

Example: Tiger Company has the following assets at 12/31/19. Prepare a proper classified
balance sheet – by section.
Land $40,000 Accounts Receivable $6,000
Cash 8,000 Equipment 23,000
Buildings 106,000 Inventory 6,800
Short-term debt investments 10,000 Prepaid Insurance 500
Long-term investments 25,000 Supplies 700
Accumulated Depreciation 15,000 Patents 5,000
Goodwill 40,000

Tiger Company
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Module 1 Class Notes – ANSWER KEY

Balance Sheet
12/31/19

Assets
Current Assets

Cash $8,000
Short Term Debt Investments 10,000
Accounts Receivable 6,000
Inventory 6,800
Supplies 700
Prepaid Insurance 500
Total Current Assets $32,000

Investments

• Investments in ___assets__ of other companies that are held for more than one
year.
• Investments in long-term assets such as land or buildings not currently being used
in operating activities.

Tiger Company
Balance Sheet
12/31/19

Assets
Investments

Long term investments $25,000

Property, Plant, and Equipment

• Property, plant and equipment assets are assets with long useful lives_ that are
currently __used______ in operating the business

• Examples:
1. Land
2. Buildings
3. Equipment

• They are also called __fixed assets__ , __plant assets_, or PPE

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• A process known as __depreciating__ is used to allocate the cost of these assets to

a number of years

• The __accumulated depreciation _ account shows the total of depreciation that a

company has taken so far on it’s assets

• On the balance sheet, the assets that are depreciated are shown at cost less
accumulated depreciation

Tiger Company
Balance Sheet
12/31/19

Assets
Property, Plant, and Equipment

Land $40,000
Building 106,000
Equipment 23,000
Less: Accumulated Depreciation (15,000)
Total Property, Plant and Equipment $154,000

Intangibles
• Assets that do not have a physical substance yet are often valuable
• Examples:
1. Trademarks
2. Patents
3. Franchise
4. Goodwill

Tiger Company
Balance Sheet
12/31/19

Assets
Intangibles
Patents $5,000
Goodwill 40,000
Total Intangibles $45,000

Current Liabilities

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 Accounting 2000
Module 1 Class Notes – ANSWER KEY

• Current liabilities are obligations that the company is to pay within the coming year
or operating cycle, whichever is longer.
• Examples:
1. Notes Payable (short term)
2. Accounts Payable
3. Salaries and Wages Payable
4. Unearned Service Revenue

• Usual order is notes payable, accounts payable, and then others in order of
magnitude (largest to smallest)

Long-Term Liabilities
• Obligations that a company expects to pay _after__ one year
• Examples:
1. Long term Notes Payable
2. Mortgage Payable
3. Bonds Payable

Stockholders’ Equity
• Stockholders’ Equity consist of two parts:

1. Common Stock
2. Retained Earnings

Ratio Analysis
• Ratio Analysis expresses the relationship among selected items of
financial statement data.
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Module 1 Class Notes – ANSWER KEY

• A __ratio__ expresses the mathematical relationship between one

quantity and another

3 types of Ratios:
Type Purpose Examples
Profitability Measure the income or operating Earnings Per Share
success of a company for a given (EPS)
period of time

Liquidity Measure the short-term ability of the Working Capital

company to pay its maturing obligations
and to meet unexpected needs for cash
Current Ratio
Solvency Measure the ability of the company to Debt to Total Assets
survive over a long period of time Free Cash Flow

EPS= Net Income – Preferred Dividends

Average Common Shares Outstanding

Working Capital = Current Assets – Current Liabilities

Current Ratio = Current Assets

Current Liabilities

Debt to Total Assets Ratio= Total Liabilities

Total Assets

Free Cash Flow = Net Cash Provided by Operating Activities – Capital Expenditures –
Dividends Paid

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 Accounting 2000
Module 1 Class Notes – ANSWER KEY

The Standard Setting Environment

___Generally Accepted Accounting Principles___(__GAAP__)__ - is a set of rules

and practices, having substantial authoritative support, that the accounting
profession recognizes as a general guide for financial reporting purposes.

• Standard-setting Bodies

Definition
Securities and Exchange Agency of the US government that oversees
Commission the US financial markets and the acct
standard-setting bodies

Financial Accounting Standards Primary accounting standard setting body in

Board (FASB) the US (makes the rules)

International Accounting Issue standards (IFRS) for countries overseas

Standards Board (IASB)

Public Company Accounting Issues auditing standards and reviews

Oversight Board (PCAOB) performance of audit firms.

• According to FASB, useful information should possess 2 fundamental

qualities:

Quality Definition
Relevant Makes a difference in a business decision
1) Predictive value
2) Confirmatory value
Faithful Representation Information depicts what really happened
1) Complete
2) Neutral
3) Free from error

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• Enhancing Qualities of Useful Information:

Qualities Definition
1. Comparability Different companies use the same accounting
principles

2. Verifiability Information that can be proved that it is free from

error.

3. Timeliness Information that is available to decision makers

before it loses capability to influence the decision.

4. Understandability Information has this quality if it is presented in a

clear and concise fashion.

5. Consistency A company uses the same accounting principles

year over year.

• Assumptions in Financial Reporting

Assumptions Definition
1. Monetary Unit Requires that only events that can be expressed
Assumption in money ($) are included in the accounting
records

2. Economic Entity Every economic entity can be separately

Assumption identified and accounted for.

3. Periodicity Life of a business can be divided into time

Assumption periods.

4. Going Concern Businesses will remain in operation for the

Assumption foreseeable future. Allows companies to keep
their asset values at cost (instead of liquidation
prices)

• Principles in Financial Reporting

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Qualities Definition
1. Full Disclosure Companies disclose all events that would make a
Principle difference in a decision

2. Historical Cost Record assets at their cost

Principle

3. Fair Value Principle Record assets/liabilities at their fair value (used

only for those assets that are actively traded,
such as investments)

• Cost Constraint:

___Materiality___ - relates to a financial statement item’s impact on a company’s overall

financial condition.

___Cost Constraint____ - providing information is costly. The cost of providing

information should not outweigh the benefits.

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Module 1 Class Notes – ANSWER KEY

Ch 02 Class Problems.

Problem 1

Suppose the following items were taken from the 2019 financial statements of Texas Instruments,
Inc. (All dollars are in millions.)
Common stock $2,826 Accumulated depreciation—equipment $3,547
Prepaid rent 164 Accounts payable 1,459
Equipment 6,705 Patents 2,210
Stock investments (long-term) 637 Notes payable (long-term) 810
Debt investments (short-term) 1,743 Retained earnings 6,896
Income taxes payable 128 Accounts receivable 1,823
Cash 1,182 Inventory 1,202

Instructions

Prepare a classified balance sheet in good form as of December 31, 2019

Texas Instruments, Inc.

Balance Sheet
12/31/2019

Assets

Current Assets
Cash $1,182
Debt investments 1,743
Accounts Receivable 1,823
Inventories 1,202
Prepaid Rent 164
Total current assets 6,114

Long-term investments
Stock Investments 637

Property, Plant and Equipment

Equipment 6,705
Less: accumulated depreciation (3,547) 3,158

Intangibles
Patents 2,210
Total assets $12,119

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Module 1 Class Notes – ANSWER KEY

Liabilities and Stockholder’s Equity

Current Liabilities
Accounts payable 1,459
Income taxes payable 128
Total current liabilities 1,587

Long Term Liabilities

Long Term Notes Payable 810

Total Liabilities 2,397

Stockholder’s Equity
Common Stock 2,826
Retained Earnings 6,896 9,722
Total Liabilities and Stockholder’s Equity 12,119

Problem 2

Presented below are the assumptions and principles discussed in this chapter.

• [Link] disclosure principle

• [Link] concern assumption
• [Link] unit assumption
• [Link] assumption
• [Link] cost principle
• [Link] entity assumption

Instructions: Identify by number the accounting assumption or principle that is described below. Do
not use a number more than once.

___2____(a) Is the rationale for why plant assets are not reported at liquidation value. (Note: Do
not use the historical cost principle.)

___6____(b) Indicates that personal and business recordkeeping should be separately

maintained.

___3___(c) Assumes that the dollar is the “measuring stick” used to report on financial
performance.

___4___(d) Separates financial information into time periods for reporting purposes.

___5___(e) Measurement basis used when a reliable estimate of fair value is not available.

___1._____(f) Dictates that companies should disclose all circumstances and events that make a
difference to financial statement users

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Module 1 Class Notes – ANSWER KEY

Problem 3

Lopez Co. had three major business transactions during 2019.

• (a)Reported at its fair value of $260,000 merchandise inventory with a cost of $208,000.

____Historical Cost Principle___________________________________________

• (b)The president of Lopez Co., Victor Lopez, purchased a truck for personal use and
charged it to his expense account.

_____Economic Entity Assumption__________________________________________

• (c)Lopez Co. wanted to make its 2019 income look better, so it added 2 more weeks to its
income statement reporting period (a 54-week year). Previous years were 52 weeks.

_____Periodicity Assumption__________________________________________

Instructions

In each situation, identify the assumption or principle that has been violated.

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