chpt 3

Questions 1. Why do businesses produce financial statements? Businesses and other organizations periodically produce financial statements that provide a formal structure for conveying financial information to decision-makers.  2. What are the four financial statements typically produced by a company? Income statement, statement of retained earnings, balance sheet, and statement of cash flows. 3. On which financial statement would one find revenues and expenses? Income statement 4. What is a gain?  A gain is an increase in the net assets of an organization created by an occurrence outside its primary or central operations. 5. How does a gain differ from a revenue? This classification split between revenues/expenses and gains/losses helps provide decision-makers with a clearer portrait of what happened to the company during the reporting period. The difference in revenue and cost of goods sold is often referred to as the company’s gross profit, gross margin, or markup. 6. What is a loss? A loss is a decrease in net assets from a similar type of incidental event. 7. How does a loss differ from an expense? Expenses are incurred to generate revenue through sales. A loss is incurred by anything not related to sales. 8. Why are revenues and expenses reported separately from gains and losses? Gains and losses are reported separately and below revenues and expenses because they are reported in less detail and because they come from activities outside the normal or primary operations of the business and are less important in telling the financial story of the business than revenues and expenses.  9. What three items are typically listed at the top of a financial statement?

The balance sheet, the income statement, and the cash flow statement. 10. Define “cost of goods sold.” A cost is identified as an asset if the benefit has value in generating  future  revenues for the company whereas an expense is a cost that has already helped earn revenues in the  past . 11. Define “gross profit.” The profit a business makes after subtracting all the costs that are related to manufacturing and selling its products or services. 12. How do companies determine if a cost is an expense or an asset? A cost is identified as an asset if the benefit has value in generating  future  revenues for the company whereas an expense is a cost that has already helped earn revenues in the  past . 13. Define “conservatism.” A principle requires company accounts to be prepared with caution and high degrees of verification . 14. Explain why dividends are not reported on the income statement. Dividends are not expenses and, therefore, must be omitted in creating an income statement. A dividend is a reward distributed by a company (through the decision of its board of directors) to the owners of its capital stock. Thus, a dividend is a sharing of profits and not a cost incurred to create revenues. 15. What are retained earnings? Retained earnings is one of the most misunderstood accounts in all of financial reporting. In simplest terms, this balance is merely the total amount of net income reported by a company since it first began operations, less all dividends paid to stockholders during that same period.  16. Define “capital stock.” Capital stock (or contributed capital) . The amount invested in the business by individuals and groups to become owners. 17. On which statement would assets and liabilities be reported? Financial statement Balance sheet

13. _F___ A gain is the amount of net income earned by a company over its life less any dividends it has paid. 14. __T__ The purpose of the balance sheet is to report the assets and liabilities of a company on a specific date. Multiple Choice 1. You are the CEO of Fisher Corporation. You are very concerned with presenting the best financial picture possible to the owners of your company. Unfortunately, Fisher has a lawsuit pending at the end of the year, which could result in the company having to pay a large sum of money. On the bright side, Fisher also has business deal that might go through, which could result in the company making a large gain. The principle of conservatism would say that which of the following is true? 1. Fisher should not report the potential loss related to the lawsuit. 2. Fisher should report the possible gain from the business deal. 3. Fisher should report the potential liability it has related to the lawsuit. 4. Fisher should report the potential cash inflow it could receive from the business deal. 2. Henderson Inc. reports the following: assets of $500,000, liabilities of $350,000 and capital stock of $100,000. What is the balance in retained earnings? 1. $450,000 2. $50,000 3. $250,000 4. $750,000 3. Giles Corporation borrowed money from Midwest Bank during the year. Where would this event be reported on Giles’s statement of cash flows? 1. Operating activities 2. Investing activities 3. Financing activities 4. It would not be reported on the statement of cash flows. 4. You are considering investing in the stock of Mogul Corporation. On which of the following statements would you find information about what a company has to help it generate revenue in the future and what the company owes to others? 1. Income statement 2. Statement of retained earnings 3. Balance sheet 4. Statement of cash flows 5. Which of the following is not a correct representation of the accounting equation? 1. Assets = Liabilities + Capital Stock + Retained Earnings 2. Assets – Liabilities = Owners’ Equity 3. Assets = Liabilities + Owners’ Equity 4. Assets + Liabilities = Owners’ Equity Problems

1. Use the following abbreviations to indicate on which statement you would find each item below. Some items may appear on more than one statement. Include all abbreviations that would apply (might be more than one). o IS: Income statement o SRE: Statement of retained earnings o BS: Balance sheet o _IS___ Sales o _BS___ Cash o _IS___ Gain on sale of building o _BS___ Retained earnings o _IS___ Salary expense o __BS__ Capital stock o _SRE___ Dividends paid o _IS___ Loss on sale of investment o _IS___ Income tax expense o _IS___ Net income 2. The following relate to Farr Corporation for the month of April: Sales Revenue $140,000 Gain on the Sale of Land $20,000 Cost of Goods Sold $75,000 Tax Expense $14,000 Advertising Expense $10,000 Dividends Paid $7,000 Loss on Lawsuit $24,000 o Determine Farr’s gross profit for the month of April. $65,00 o Determine Farr’s net income for the month of April. $37,00 o If retained earnings at the beginning of April were $1,500,000, what would retained earnings be at the end of April? $1,530,000 3. Maverick Company has the following account balances at the end of December. Show that Maverick’s balance sheet would balance using the accounting equation. Cash $8,000 Capital Stock $120,000 Inventory $16,000 Note Payable $45,000 Retained Earnings $29,000 Building $150,000 Equipment $20,000 $212,000(assets)=$63,000(liabilities)+$149,00(owner's equity)