Chapter 4: Financial Statement Analysis

Question 1

Why Study Financial Statements

Answer 1

1. Assess current performance through financial statement analysis
2. Monitor and control operations, and
3. Forecast future performance.

Question 2

What Are The Fundamental Concepts and Assumptions?

Answer 2

• Separate Entity Concept
• Cost Principle
• Monetary Measurement Concept
• Going Concern Assumption

Question 3

The organizational unit for which accounting records are maintained.

Answer 3

Entity

Question 4

The activities of an entity are to be separate from those of its individual owners.

Answer 4

Separate entity concept

Question 5

In the Cost Principle

All transactions are recorded at _______________.

Answer 5

historical cost

Question 6

is assumed to represent the fair market value of the item at the date of the transaction because it reflects the actual use of resources by independent parties.

Answer 6

Historical cost

Question 7

Accountants measure only those ____________________ that can be measured in monetary terms.

Answer 7

economic activities

Question 8

Listed values may not be the same as actual market values:

Answer 8

• Inflation
• Measurement issues

Question 9

An entity will have a continuing existence for the foreseeable future.

Answer 9

The Going Concern Assumption

Question 10

The life of a business is divided into distinct and relatively short time periods so the accounting information can be timely, generally 12 months or less.

Answer 10

The Time Period Concept

Question 11

Revenues are recorded when two main criteria are met:

1. The earning process is substantially complete
2. Cash has either been collected or collection is reasonably assured.

Answer 11

Revenue Recognition

Question 12

All costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues.

Answer 12

The Matching Principle

Question 13

This process of matching expenses with recognized revenues determines the amount of net income reported on the income statement.

Answer 13

The Matching Principle

Question 14

Basic financial statements:

Answer 14

• Balance Sheet
  Income Statement
  ŽStatement of Retained Earnings
  Statement of Cash Flows

Question 15

Summary of the financial position of a company at a particular date

Answer 15

The Balance Sheet

Question 16

financial statement that indicates the worth or financial condition of a business as of a certain date.

Answer 16

The Balance Sheet

Question 17

Sources owned by the company like cash, accounts receivable, inventory, land, buildings, equipment and intangible items

Answer 17

Assets

Question 18

The total amount of money the firm owes its creditors like accounts payable, notes payable and mortgages payable

Answer 18

Liabilities

Question 19

net assets after all obligations have been satisfied or is the difference in the value of the firm’s assets and the firm’s liabilities

Answer 19

Owners’ Equity

Question 20

consists of firm’s cash plus other assets the firm expects to convert to cash within 12 months or less, such as receivables and inventory.

Answer 20

Current Assets

Question 21

are assets that the firm does not expect to sell within one year. For example, plant and equipment, land.

Answer 21

Fixed assets

Question 22

represent the amount that the firm owes to creditors that must be repaid within a period of 12 months or less such as accounts payable, notes payable.

Answer 22

Current liabilities

Question 23

refer to debt with maturities longer than a year such as bank loans, bonds.

Answer 23

Long-term liabilities

Question 24

The amount the company received from selling stock to investors.

Answer 24

The stockholder’s equity

Question 25

It may be shown as common stock in the balance sheet or it may be divided into two components:

Answer 25

- par value - additional paid in capital above par

Question 26

is the stated or face value a firm puts on each share of stock.

Answer 26

Par value

Question 27

is the additional amount the firm raised when it sold the shares.

Answer 27

Paid in capital

Question 28

the portion of net income that has been retained (i.e., not paid in dividends) from prior years operations.

Answer 28

retained earnings

Question 29

users can identify significant changes over time. They have more than one year on the Balance Sheet.

Answer 29

Comparative financial statement

Question 30

—are useful to use, since information is then organized into a format that is more readable than a simple listing of all the accounts that comprise a balance sheet.

Answer 30

Classified financial statements a

Question 31

Balance Sheet Limitations

Answer 31

ŒAssets recorded at historical value Only recognizes assets that can be expressed in monetary terms ŽOwners’ equity is usually less than the company’s market value

Question 32

Shows the results of a company’s operations (activities) over a period of time.

Answer 32

The Income Statement

Question 33

show the reader how much profit or loss an organization generated during a reporting period.

Answer 33

The Income Statement

Question 34

Earnings from sale of goods or performance of services

Answer 34

Total Sales

Question 35

Assets (cash or AR) created through business operations

Answer 35

Revenues

Question 36

Refunds and adjustments for unsatisfactory merchandise or service

Answer 36

Sales Returns and Allowances

Question 37

—Total sales minus sales returns or allowances

Answer 37

Net Sales

Question 38

Cost to the business for merchandise or goods sold

Answer 38

Cost of Goods Sold

Question 39

Overhead or cost incurred in operating a business

Answer 39

Operating Expenses

Question 40

Revenues - Expenses

Answer 40

Net Income or (Net Loss)

Question 41

An additional financial statement that identifies changes in retained earnings from one accounting period to the next.

Answer 41

Statement of Retained Earnings

Question 42

How to get ending retained earnings

Answer 42

Beg. RE + Net Income - Dividends Paid

Question 43

Net income results in:

Answer 43

Increase in net assets Increase in retained earnings Increase in owners’ equity

Question 44

Dividends result in:

Answer 44

Decrease in net assets Decrease in retained earnings Decrease in owners’ equity

Question 45

Reports the amount of cash collected and paid out by a company in operating, investing and financing activities for a period of time.

Answer 45

Statement of Cash Flows

Question 46

Complementary to the income statement.

Answer 46

Statement of Cash Flows

Question 47

Indicates ability of a company to generate income in the future.

Answer 47

Statement of Cash Flows

Question 48

is used by firms to explain changes in their cash balances over a period of time by identifying all of the sources and uses of cash.

Answer 48

Statement of Cash Flows

Question 49

— Sell goods or services — Sell other assets or by borrowing — Receive cash from investments by owners

Answer 49

Cash inflows

Question 50

— Pay operating expenses — Expand operations, repay loans — Pay owners a return on investment

Answer 50

Cash outflows

Question 51

Cash Inflow * Sale of goods or services * Sale of investments in trading securities * Interest revenue * Dividend revenue Cash Outflow * Inventory payments * Interest payments * Wages * Utilities, rent * Taxes

Answer 51

Operating Activities

Question 52

Cash Inflow * Sale of plant assets * Sale of securities, other than trading securities * Collection of principal on loans Cash Outflow * Purchase of plant assets * Purchase of securities, other than trading securities * Making of loans to other entities

Answer 52

Investing Activities

Question 53

Cash Inflow * Issuance of own stock * Borrowing Cash Outflow * Dividend payments * Repaying principal on borrowing * Treasury stock purchase

Answer 53

Financing Activities

Question 54

is any activity that brings cash into the firm. For example, sale of equipment.

Answer 54

Source of cash

Question 55

is any activity that causes cash to leave the firm. For example, payment of taxes.

Answer 55

Use of cash