Textbook on Balance Sheet

Question 1

What do financial statement users look to the balance sheet for?

Answer 1

To determine an entity’s ability to generate future cash flows and to evaluate its exposure to risk.

Question 2

What makes a balance sheet strong?

Answer 2

Having limited obligations so that a company can make timely debt payments.

Question 3

What is a healthy balance sheet?

Answer 3

A balance sheet that has adequate cash and other assets for managing day-to-day operations, for making timely debt payments, for stimulating future growth, and for funding any unexpected needs.

Question 4

The four basic financial statements interrelate, or ________________ to provide comprehensive information on a company’s operating performance and financial position.

Answer 4

articulate

Question 5

A key source of essential information regarding a company’s accounting policies that further explain the amounts reported in financial reports are the ____________.

Answer 5

notes

Question 6

The financial statements are usually part of a company’s annual report to shareholders, which also includes additional _________________________ that supplement and enhance the financial statements.

Answer 6

disclosures

Question 7

The statement of financial position, also called the balance sheet, lists an entity’s assets, liabilities, and equity as of a specific point in ___________.

Answer 7

time.

Question 8

The balance sheet consists of ________________ accounts which are not closed at year-end and have cumulative balances that the company carries forward period to period over the life of the firm.

Answer 8

permanent

Question 9

An entity’s ability to respond to unexpected needs and opportunities by taking actions that alter the amounts and timing of cash flows is known as financial ___________________________.

Answer 9

flexibility

Question 10

What is the relationship between an entity’s financial flexibility and risk? The greater an entity’s financial flexibility, the ________ its risk.

Answer 10

lower

Question 11

What are the limitations of the balance sheet?

Answer 11

• Use of Historical Costs: Many of the accounts on the balance sheet are reported at historical cost as opposed to market values or liquidation values. For example, assume an entity purchased land 10 years ago for $1,000 that now has a market value of $10,000. The firm reports the asset on the balance sheet under U.S. GAAP at the historical cost of $1,000. In this way, relying on historical costs limits the relevance of information in the balance sheet.
• Use of Estimates: Many of the accounts reported on the balance sheet are based on estimates as opposed to determinable amounts. For example, the net realizable value of accounts receivable is based on the estimated amount of cash that the entity expects to collect.
• Some Assets and Liabilities are Not Reported: A number of assets and liabilities are not reported on the balance sheet. For example, assets such as human capital and a company’s reputation for quality products will not be reported on the balance sheet.

Question 12

What are three common cash flow measures that are based on balance sheet information?

Answer 12

liquidity, solvency, and financial flexibility

Question 13

Which three areas does the balance sheet provide critical information to financial statement users?

Answer 13

1. Summarizes the economic resources and obligations that impact the entity’s ability to generate future cash flows.
2. Is useful in assessing an entity’s rate of return on its investments when examined in conjunction with the income statement.
3. Aids in assessing the risk associated with an entity by providing inputs for cash flow measures of liquidity, solvency and financial flexibility.

Question 14

A measure of an asset’s nearness to cash—that is, how quickly the firm can convert assets into cash and pay liabilities with minimal risk of loss is known as ___________________.

Answer 14

liquidity.

Question 15

The cash flow measure that allows investors to determine whether an entity will have the resources needed to pay its currently maturing obligations, pay dividends, and/or buy back its own equity shares is __________________.

Answer 15

liquidity.

Question 16

Thus, the more liquid an entity, the ____________ the risk associated with that entity.

Answer 16

lower

Question 17

The cash flow measure of a firm’s long-term ability to pay its obligations as they mature is known as _____________.

Answer 17

solvency.

Question 18

A firm with a high level of debt relative to its equity may have difficulty meeting the fixed payments associated with its debt and therefore is in a position of low _____________________ .

Answer 18

solvency.

Question 19

Various financial ratios that are used to measure both ___________________ and ____________________.

Answer 19

• liquidity
• solvency

Question 20

What are the three primary classifications on the balance sheet?

Answer 20

assets, liabilities, and stockholders’ equity

Question 21

The balance sheet utilizes sub-classifications within each of these broad groups that enhance the usefulness of the balance sheet by grouping the accounts according to characteristics such as nature, function, or size. One of the primary distinctions is current versus ______________.

Answer 21

noncurrent or long-term

Question 22

Resources that the firm expects to convert to cash, use, or consume in a period of more than one year or one operating cycle, whichever is longer are called ____________________ assets.

Answer 22

noncurrent

Question 23

Obligations that are due after one year or one operating cycle, whichever is longer are ____________ liabilities.

Answer 23

noncurrent

Question 24

What are the balance sheet classifications for assets?

Answer 24

Assets are generally subdivided on the balance sheet as current assets; long-term investments; property, plant, and equipment; intangible assets; and other assets.

Question 25

What are balance sheet classifications for liabilities?

Answer 25

Liabilities are generally classified on the balance sheet as either current or noncurrent.

Question 26

What are the four major components of stockholders’ equity?

Answer 26

Stockholders’ equity, also referred to as shareholders’ equity and owners’ equity, is generally separated into four major categories: contributed capital, retained earnings, accumulated other comprehensive income, and noncontrolling interest.

Question 27

What are the balance sheet classifications for assets, liabilities and stockholders’ equity?

Answer 27

Question 28

Resources that the firm expects to convert to cash, to use, or to consume within one year or one operating cycle, whichever is longer are called ______________ assets.

Answer 28

current

Question 29

The period of time from the acquisition of goods to the point at which the entity receives cash from the sale of the goods is called the ___________________ cycle.

Answer 29

operating

Question 30

Current assets primarily include:

Answer 30

• Cash and cash equivalents.
• Short-term investments.
• Accounts receivable.
• Inventory.
• Prepaid expenses.

Question 31

Cash includes:

Answer 31

cash (coins, currency, and money orders)

Question 32

What are cash equivalents?

Answer 32

Short-term, highly liquid investments acquired with three months or less to maturity.

Question 33

Cash equivalents include:

Answer 33

• Commercial paper (i.e., short-term loans receivable from high-quality corporations sold by commercial banks).
• Money market funds.
• U.S. Treasury bills. For example, a three-year Treasury instrument acquired with two months to maturity is a cash equivalent.

Question 34

What are short-term investments?

Answer 34

Investments that are not classified as cash equivalents which are investments in debt or equity securities of other corporations or governmental entities that the entity has the ability and intent to sell within the next year or operating cycle, whichever is longer.

Example: An entity classifying 100 shares of Microsoft that it intends to sell within the next year.

Question 35

Amounts owed to the entity resulting from the sale of goods or services to customers on credit and require no formal written agreement are __________.

Answer 35

accounts receivable

Question 36

Tangible property that is either (a) held for sale in the ordinary course of business, (b) used as raw materials in the manufacturing process to produce finished goods to be sold in the ordinary course of business, or (c) held as supplies to be currently consumed when providing goods or services are known as _____________.

For a retail or wholesale business, _______________ includes all goods held for resale. In the case of a manufacturing company, ______________ is made up of three components: raw materials, work-in-process, and finished goods. ______________ is classified as a current asset.

Answer 36

inventory

Question 37

Assets that arise when expenses are paid before they are incurred and are typically considered current assets because the benefits associated with these prepayments are usually consumed within a year or operating cycle if longer are known as __________ expenses.

Answer 37

prepaid

Question 38

What are some examples of prepaid expenses?

Answer 38

prepaid rent and prepaid insurance

Question 39

Noncurrent assets that are not used directly in the operations of the business or where management does not intend to convert them into cash within the next year (or operating cycle, if longer) are known as ______________ investments.

Answer 39

long-term

Question 40

Investments in debt and equity securities and investments in land and other property that are not used in operations are examples of _____________ investments.

Answer 40

long-term

Question 41

Assets that are tangible, long-lived, and used in the production and sale of the company’s goods and services and includes items such as buildings, land, machinery and equipment, office furniture and equipment, and natural resources are known as _________________________.

Answer 41

property, plant, and equipment

Question 42

All property, plant, and equipment is reported on the balance sheet net of accumulated depreciation or depletion except for ______________, which is not depreciated.

Answer 42

land

Question 43

Assets that lack physical substance but have economic value due to the rights they confer upon the holder are known as ______________ assets.

Answer 43

intangible

Question 44

Trademarks, trade names, broadcast licenses, patents, copyrights, and franchises are known as ___________ assets.

Answer 44

intangible

Question 45

How is it determined whether an intangible asset is amortized or not?

Answer 45

Intangible assets that have a definite or finite useful life are amortized whereas those that have an indefinite life are not amortized

Question 46

Obligations that the firm expects to liquidate through the use of current assets or the creation of other ___________ liabilities. and will typically be paid within one year or operating cycle, whichever is longer are known as ______________ liabilities.

Answer 46

current

Question 47

Current liabilities commonly include:

Answer 47

• Accounts payable.
• Short-term notes payable.
• Current maturities of long-term debt.
• Accrued liabilities.
• Unearned revenues.

Question 48

Obligations due to suppliers of goods or services incurred in the normal course of business operations where there is no formal, written agreement required and no interest is charged because they are are due within 30 to 60 days is known as __________ payable.

Answer 48

Accounts payable (also called trade payables)

Question 49

Formal, written promises to pay cash at a fixed maturity date in the future with either a fixed rate of interest or no interest and the maturity date is within the next year or operating cycle, if longer is known as short-term _________ payable.

Answer 49

short-term notes payable

Question 50

The portion of any long-term debt that is payable within the next year or operating cycle, if longer is known as ___________ maturities of long-term debt.

Answer 50

current maturities of long-term debt

However, this amount must be paid from current assets or result in the creation of other current liabilities in order to be classified as current. For example, if the maturity of the debt is extended or if the debt is replaced by equity or other long-term debt, the debt is classified as long term.

Question 51

Expenses incurred by an entity that remain unpaid at the end of the accounting period such as utilities payable, wages and salaries payable, interest payable, and taxes payable and will be paid within the next year or operating cycle, if longer are known as ________ liabilities.

Answer 51

accrued liabilities

However, if the entity will not pay an accrued liability within the next year, it classifies it as a long-term liability.

Question 52

Liabilities resulting from advance collections of cash from a customer for goods or services to be provided in the future under existing sales or service contracts and where the firm will remove the liability from the balance sheet when it provides the goods or services to the customer are known as ____________ revenues.

Answer 52

unearned revenues (sometimes referred to as deferred revenues)

However, if the firm will not provide the goods or services associated with the unearned revenues to the customer within the next year (or operating cycle, if longer), it classifies the unearned revenue as a long-term liability.

Question 53

Obligations an entity does not expect to satisfy within one year or operating cycle, whichever is longer and are not liquidated through the use of current assets or the creation of other current liabilities are known as _________________ liabilities.

Answer 53

noncurrent liabilities

Question 54

Long-term notes payable, the long-term portion of capital lease obligations, bonds payable, and pension obligations are examples of ______________ liabilities.

Answer 54

noncurrent liabilities

Question 55

Stockholders’ equity, also referred to as shareholders’ equity and owners’ equity, is generally separated into four major categories. What are these categories?

Answer 55

• contributed capital
• retained earnings
• accumulated other comprehensive income
• noncontrolling interest

Question 56

The face or stated value on the share certificate is its _______ value, which is an arbitrary value that the organizers of the corporation place on the stock.

Answer 56

par value

Question 57

The amounts invested by shareholders which includes the stock sold by the entity at face or par value and amounts received above par value, known as additional paid-in capital or paid-in capital in excess of par are known as _____________________ capital.

Answer 57

Contributed capital (also called paid-in capital)

Question 58

The change in an entity’s equity during the period resulting from transactions with nonowners. In other words, it includes all changes in equity during a period except those changes that result from investments and distributions to owners.

Answer 58

Comprehensive income

Question 59

The sum of net income and other comprehensive income. (Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from net income but included in comprehensive income.)

Answer 59

Comprehensive income

Question 60

The cumulative earnings (losses) of the company that have not been distributed as dividends to shareholders are known as _______________.

Answer 60

retained earnings.

Question 61

The cumulative amount of other comprehensive income (or loss) over the life of the entity are known as ________________.

Answer 61

accumulated other comprehensive income (or loss)

Question 62

When one company controls another company (e.g., a subsidiary) but owns less than 100% of its voting shares, and the other controlling company adds all of the subsidiary’s assets and liabilities to its own balance sheet is known as a ____________________ interest, the amount of the company’s net assets owned by outside shareholders.

To illustrate, assume a parent company owns 90% of the voting shares of a subsidiary that reports $100 in assets and $40 in liabilities. The shareholders’ equity (net assets) of the subsidiary is equal to $60 with $6 (10% * $60) of the net assets owned by the noncontrolling interest.

Answer 62

noncontrolling

Question 63

After grouping assets as current and noncurrent, companies make further classifications. Specifically, within current and noncurrent assets, companies list each asset in decreasing order of _____________.

Answer 63

liquidity.

Question 64

Companies list liabilities in increasing order of ___________. That is, current liabilities are listed before long-term liabilities. Also, within each group, the individual liability accounts are listed in order of _______________.

Answer 64

maturity

Question 65

What are the two forms of balance sheet format?

Answer 65

1. The account format lists assets on the left side and liabilities and stockholders’ equity on the right side of the statement.
2. The report format lists liabilities and stockholders’ equity directly below assets on the same page.

Question 66

The intrinsically interrelated relationships among financial statement elements where net income is included in stockholders’ equity on the balance sheet, and where net income and the balance sheet are used to prepare the statement of cash flows is is known as financial statement ________________.

Answer 66

articulation

Question 67

Show a diagram of financial statement articulation:

Answer 67

Question 68

Show an example of financial statement articulation:

Answer 68

Question 69

Give a summary of the four primary financial statements and financial statement articulation.

Answer 69

Question 70

The four main financial statements are:

Answer 70

Statements of Net Income and Comprehensive Income

Statement of Stockholders’ Equity

Statement of Financial Position

Statement of Cash Flows

Question 71

Financial statement __________ makes clear the interaction among assets, liabilities, and equity elements with revenues and expenses.

Answer 71

articulation

Question 72

Financial statement articulation for the Statements of Net Income and Comprehensive Income include:

Answer 72

Net income = Revenues - Expenses + Gains - Losses

Comprehensive Income = Net Income + Other Comprehensive Income (OCI)

Question 73

Financial statement articulation for the the Statement of Stockholders’ Equity include:

Answer 73

Ending Retained Earnings = Beginning Retained Earnings + Net income - Dividends Declared +/- Other

Ending Accumulated OCI = Beginning Accumulated OCI +/- OCI

Question 74

Financial statement articulation for the Statement of Financial Position include:

Answer 74

Assets = Liabilities + Stockholders’ Equity

Question 75

Financial statement articulation for the Statement of Cash Flows include:

Answer 75

Net Change in Cash = Ending Cash - Beginning Cash

Question 76

An integral part of the financial statements that are typically extensive provide descriptive information regarding a company’s accounting policies, supplemental disclosures of items not reported on the financial statements, and additional details for transactions reported on the four main financial statements.

Answer 76

the notes (or footnotes)

Question 77

Notes are an integral part of the financial statements and provide additional information related to the line items presented. The notes both expand on financial information included in the financial statements and provide additional disclosures. Examples of notes that provide additional disclosures include:

Answer 77

• Summary of significant accounting policies: Details the methods that the entity has selected in reporting various accounts.
• Subsequent events: Describes significant events that occur after the date of the fiscal year-end but before the financial statements are issued or available to be issued.
• Going concern uncertainties: Management must evaluate whether there is substantial doubt as to whether the entity will continue to operate within one year after the financial statements
  are issued. If substantial doubt does exist, disclosures are required.
• Related-party transactions: Details transactions that an entity engages in with owners, firm management, affiliated entities, or any other entity that can exert significant influence on the company

Question 78

Details the methods that the entity has selected in reporting various accounts.

Answer 78

Summary of significant accounting policies

Question 79

The definitions, policies, and methods used to account for areas such as cash equivalents; investments; property, plant, and equipment; revenue recognition; inventories; intangible assets and goodwill; financial instruments; product liability; credit risk; research and development; income taxes; and earnings per share that are disclosed by companies in the first footnote is known as the summary of ______________ accounting policies.

Answer 79

significant

Question 80

Describes significant events that occur after
the date of the fiscal year-end but before the financial statements are issued or available to be issued.

Answer 80

Subsequent events

Question 81

An event that occurs after the date of the fiscal year-end but before the financial statements are issued or available to be issued is known as a ________________ event.

Answer 81

subsequent

Question 82

The sale of a business, the issuance of debt or equity securities, and the settlement of litigation are examples of _________________ events.

Answer 82

subsequent

Question 83

When should a firms recognize material subsequent events in the financial statements for the preceding year and when should a firm disclose them in the notes to the financial statements?

Answer 83

The recognition versus disclosure decision depends upon whether the event relates to a condition that existed on the balance sheet date (the end of the fiscal year):

1. If the condition existed as of the balance sheet date, the firm should make an adjustment to the financial statements to account for the subsequent event.
2. If the condition did not exist as of the balance sheet date, the entity is required to disclose only the subsequent event as opposed to adjusting the financial statements.

Question 84

Management must evaluate whether there is substantial doubt as to whether the entity will
continue to operate within one year after the financial statements are issued. If substantial doubt does exist, disclosures are required.

Answer 84

Going concern uncertainties

Question 85

Details transactions that an entity engages in with owners, firm management, affiliated entities, or any other entity that can exert significant influence on the company.

Answer 85

Related-party transactions

Question 86

Explain the going concern concept.

Answer 86

The going concern concept indicates that accountants record transactions and prepare financial statements if the entity will continue to operate for an indefinite period of time unless there is evidence to the contrary.

Management must evaluate whether there is substantial doubt as to whether the entity will continue to operate within one year after the financial statements are issued. If substantial doubt does exist, then management must consider any plans it has to mitigate the entity’s going concern issue. If it is probable that these plans will be implemented and will alleviate the conditions that raise doubt about the entity’s ability to continue operating, then the entity must disclose information about:
* The conditions or events that raised substantial doubt about the entity’s ability to continue operations.
* Management’s evaluation of the significance of those conditions.
* Management’s plans that alleviate substantial doubt about the entity’s continued operations. If conditions exist that raise substantial doubt about the entity’s ability to continue as a going concern and this doubt is not alleviated by management’s plans, then the entity must disclose that there is substantial doubt about the entity’s ability to continue as a going concern within one year from the date that the financial statements are issued (or available to be issued).

Additionally, the entity should disclose information about:
* The conditions that raise substantial doubt about the entity’s ability to continue operations.
* Management’s evaluation of the significance of those conditions.
* Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern.

Question 87

Explain related-party transactions.

Answer 87

Related-party transactions are transactions that an entity engages in with owners, firm management, affiliated entities, or any other entity that can exert significant influence on the company.16 FASB requires disclosure of related-party transactions because it is possible that the transaction was not objective and not completed at market prices. For example, if a corporate officer borrows funds from her employer, she may do so below the market rate of interest. The disclosure of a related-party transaction must include:

1. The nature of the relationship.
2. A description of the transaction.
3. The amount of the transaction.
4. Any amounts due from or to related parties.