chapter 1 introduction to accounting and business … · chapter 1 introduction to accounting and...

Chapter 1

Introduction to Accounting and Business

Study Guide

1 ©2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to publicly accessible website, in whole or in part.

Do You Know…?

Learning Objective 1: Describe the nature of business and the role of accounting and ethics in business. □ How to distinguish among service, manufacturing, and merchandising businesses? (See

exercises 1–3) □ How to differentiate between the types of accounting and the users of each? (See

exercises 4–6)

Learning Objective 2: Describe generally accepted accounting principles, including the underlying assumptions and principles. □ The characteristics of each type of business entity? (See exercises 8–10) □ The different assumptions and principles that financial accounting and generally

accepted accounting principles are based upon? (See exercises 7, 11–12)

Learning Objective 3: State the accounting equation and define each element of the equation. □ The components of the accounting equation and how to solve for an unknown amount?

(See exercises 13–15)

Learning Objective 4: Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation. □ The effect of business transactions on the accounting equation? (See exercises 16–18)

Learning Objective 5: Describe the financial statements of a corporation and explain how they interrelate. □ The financial statements of a business, the order in which they are prepared, and the

purpose of each? (See exercises 19–21) □ How to prepare the income statement? (See exercises 22, 26, 30) □ The transactions that affect a retained earnings statement and how to prepare one?

(See exercises 23, 27, 31) □ How to prepare the balance sheet? (See exercises 24, 28, 32) □ How to prepare the statement of cash flows, including the types of transactions in each

section? (See exercises 25, 29, 33)

Learning Objective ADM: Describe and illustrate the use of the ratio of liabilities to stockholders’ equity in evaluating a company’s financial condition. □ The ratio of liabilities to stockholders’ equity and the meaning of any changes? (See

exercises 34–36)

2 Chapter 1

©2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to publicly accessible website, in whole or in part.

Fill-in-the-Blank Equations

1. Assets = Liabilities + __________ 2. Revenues – Expenses = __________ 3. Beginning retained earnings + __________ – Dividends = Ending retained earnings 4. Cash flows from operating activities + __________ + Cash flows from financing activities

= Net increase/decrease in cash 5. Total liabilities ÷ Total stockholders’ equity = __________

Exercises

1. Determine if each of the following businesses is an example of a manufacturing, service, or merchandising business.

a. Accountant preparing a tax return

b. Grocery store

c. Clothing producer

2. Are the following examples of a service, manufacturing, or merchandising business?

a. Store selling school supplies

b. Lawyer providing legal advice

c. Car factory

3. Determine if each of the following is an example of a manufacturing, service, or merchandising business.

a. Gas station

b. Pencil producer

c. Auto repairman

4. Are the following examples of managerial or financial accounting?

a. Creating an income statement

b. Preparing a budget for the production department

c. Valuing investments to record gains and losses for the period’s financial statements

Introduction to Accounting and Business 3


5. Are the following stakeholders internal or external users in a company? Would each use managerial or financial accounting?

a. Stockholders of a corporation

b. Marketing manager

c. Bank providing financial loans

6. Would each of the following be an example of managerial or financial accounting?

a. Preparing a valuation of the company’s assets to apply for a bank loan

b. Projecting sales to determine the amount of materials to purchase

c. Allocating the marketing expense to various departments

7. Determine the accounting assumption that relates to each of the following descriptions.

a. Only the relevant economic data in an accounting system related to the activities of the business are observed.

b. The financial reports are expressed in a single money unit.

c. Financial condition and changes in financial condition are reported periodically on a consistent basis.

8. Determine if each of the following is a characteristic of a proprietorship, partnership, corporation, or limited liability company.

a. Separate legal taxable entity

b. Owned by one individual

c. Combination of a corporation and partnership

d. Combines the resources and skills of two or more individuals

9. Determine the type of business entity from the following independent characteristics.

a. Michael owns a fishing company that has resources limited to his own.

b. Wyatt and Matthew own stock in their farming company.

c. Jack and Jill are the only owners in a company whose resources are limited to their own.

d. Owen has a business that is taxed like a partnership but has limited liability like a corporation.

4 Chapter 1


10. Do the following separate qualities describe a proprietorship, partnership, corporation, or limited liability company?

a. Joe and Jack’s business will have characteristics of a corporation and partnership.

b. Howard will support his company using debt securities and stock.

c. Katie is the only owner of her business and has full liability for any losses.

d. Cooper and Eric operate a business together with personal liability.

11. Which accounting principle do the following characteristics define?

a. Revenue is recorded when the services have been performed or goods are delivered to the customer.

b. Amounts that are recorded and reported must be based upon independent, unbiased evidence and must be able to be confirmed by a third party.

c. An item is recorded at its initial transaction price.

12. Which accounting principle relates to the following examples?

a. Schoolhouse’s equipment increases in value, but the balance sheet values the asset at its purchase price.

b. In order to record the purchase of inventory, the accountant must verify the amounts with the purchase order.

c. Starr Corporation records expenses in the same period as the related revenue.

13. If a business has the following balances, how much is total liabilities?

Assets Cash

$ 5,000

Accounts receivable 2,575 Equipment 14,000

Liabilities Total liabilities ?

Stockholders’ Equity Common stock and additional paid-in capital $ 700 Retained earnings 1,900

14. During the first year, Fox Supply has total assets of $15,000 and liabilities of $10,875. During the second year, assets increase by $1,375, and stockholders’ equity increases by $950. How much is total liabilities at year-end?



15. Shell Company’s year 5 balance sheet had the following balances: stockholders’ equity of $4,600 and liabilities of $3,800. During the next year, assets increased by $300 and liabilities decreased by $150. What was the change in stockholders’ equity?

16. Determine the dollar effect on the accounting equation (increase or decrease assets, liabilities, or stockholders’ equity) from the following separate transactions.

a. Dillon contributes $4,000 of cash to his corporation in exchange for common stock.

b. Cowboy Corporation purchases equipment with a 10-year note payable for $1,600 and $400 cash.

c. Queen Bee pays off $1,300 of accounts payable.

17. What is the dollar effect on the accounting equation (increase or decrease assets, liabilities, or stockholders’ equity) from the following independent transactions?

a. Brick Company pays $800 for rent expense for the month.

b. Peach Company receives $290 in interest revenue.

c. Purple Sun pays a dividend of $1,400 to shareholders.

6 Chapter 1


18. Apple Tree had the following balances when formed:

Assets Cash

$2,400

Equipment 1,300 Total assets $3,700

Liabilities Notes payable $1,500

Stockholders’ Equity Common stock 2,200 Total liabilities and stockholders’ equity $3,700

During the first year of operations, the following transactions occurred:

• Earned $12,000 in rental revenue.

• Made a $2,000 investment in equity securities using $1,000 cash and a $1,000 note payable.

• Incurred and paid $2,000 in utilities expense, $3,500 in rent expense, and $2,200 in wages expense.

• Issued an additional 200 shares of common stock for $1,500 and paid $200 in dividends.

Show the cumulative effect on the accounting equation from the transactions for the year.

19. Determine to which financial statement the following descriptions relate.

a. Shows the account balances at year-end

b. Details the changes in cash for the year

c. Demonstrates the activity of a company during the year to arrive at a net income or loss

d. Reports changes in retained earnings for the year

20. Which financial statement is associated with each of the descriptions below?

a. Operating activities, investing activities, and financing activities

b. Assets, liabilities, and stockholders’ equity

c. Revenues and expenses

d. Net income, dividends, and beginning retained earnings



21. Which financial statement is associated with each of the descriptions below? Also, put the financial statements in order as they should be prepared.

a. Reports cash payments and receipts for a time period

b. Ensures that assets are equal to the sum of liabilities and stockholders’ equity at the end of a time period

c. Identifies the changes in retained earnings during a time period

d. Arrives at net income or net loss for a time period

22. Given the following transactions for the year, prepare the income statement for World Co. for the year ended December 31, 20Y5.

• Rental revenue of $15,000

• Wages expense of $3,500

• Rental expense of $5,300

• Miscellaneous expense of $1,200

23. Create World Co.’s retained earnings statement using net income or net loss from Exercise 22. Retained earnings had a zero balance at the beginning of the company’s first year of operations. The company paid dividends of $2,100 for the year.

24. Using the information from Exercise 23, prepare World Co.’s balance sheet if the company had the following balances:

• Accounts payable: $2,300

• Inventory: $6,500

• Accounts receivable: $1,400

• Cash: $1,500

• Property, plant, and equipment: $12,000

• Notes payable: $1,700

• Common stock: $14,500

8 Chapter 1


25. Prepare World Co.’s statement of cash flows using the year-end amount from Exercise 24. The company had a zero balance in cash at the beginning of the year. During the first year of operations, the following activities occurred:

• Cash revenue of $13,600

• Cash received from issuing common stock for $1,500

• Cash payments for operating expenses of $10,000

• Cash received from notes payable of $1,800

• Purchase of new equipment, $3,300

• Cash dividends to stockholders, $2,100

26. If the following transactions occurred for the year June 30, 20Y5, what is Purple Sun’s net income or net loss? Find the amount using an income statement.

• Earned fees of $21,700

• Utilities expense of $2,300


• Interest expense of $1,200


27. Using the net income or net loss found in Exercise 26, create Purple Sun’s retained earnings statement. The retained earnings at the beginning of the year equaled $16,700. The company paid $6,200 in dividends during the year.

28. Create Purple Sun’s balance sheet using the amounts found in Exercise 27 and the following account balances:


• Cash: $6,400


• Investments in securities: $1,500




29. At the beginning of the year, Purple Sun had a cash balance of $3,300. Prepare the statement of cash flows given the following information and the ending cash balance from Exercise 28.

• Purchased land for $12,000; $6,000 cash and issued $6,000 long-term note payable to the seller

• Cash received from customers, $20,000

• Cash received from issuing common stock for $2,300 cash

• Cash dividends to shareholders, $6,200

• Cash payments for operating expenses, $7,000

30. With the following transactions, create Polka Dot’s income statement for the year ended September 30, 20Y5.

• Interest revenue of $23,000

• Interest expense of $14,000

• Rent expense of $4,000

• Legal expense of $1,400



31. Polka Dot had a beginning balance of $3,000 for retained earnings. During the year, the company paid a cash dividend of $1,000. Prepare the retained earnings statement for the year using the net income or net loss and information from Exercise 30.

32. Using the ending retained earnings balance from Exercise 31, create Polka Dot’s balance sheet. The company had the following ending account balances:

• Cash: $3,250

• Investment in securities: $22,000

• Notes payable: $19,500


• Interest payable: $4,200



10 Chapter 1


33. At the beginning of the year, Polka Dot’s bank statement showed a balance of $6,250 for cash. With the transactions below, reconcile the beginning to ending amount from Exercise 32 using a statement of cash flows.

• Cash received from interest, $20,000

• Cash paid for interest, $12,000

• Cash paid for operating expenses, $17,300

• Cash dividends, $1,000

• Cash paid for new building, $5,000

• Cash received from customers, $12,000

34. Given the following company’s balances for liabilities and stockholders’ equity, calculate the ratio of liabilities to stockholders’ equity. Round answers to two decimal places. Indicate the company with the lowest risk for stockholders and the company with the highest risk.

Company Liabilities Stockholders’ Equity World Co.

$ 3,500 $16,400

Purple Sun 4,000 22,500 Polka Dot

28,700 200

35. Blue Company’s account balances for liabilities and stockholders’ equity for the past two years are shown below. Calculate the ratio of liabilities to stockholders’ equity, rounding to two decimal places. Then, indicate if the company’s stockholders are more or less at risk.

12/31/20Y6 12/31/20Y5

Liabilities $15,000 $14,750 Stockholders’ equity 14,800 14,000

36. Calculate the ratio of liabilities to stockholders’ equity with the information given for Broom Co., rounding to two decimal places. Then, indicate if the company’s stockholders are more or less at risk than the previous year.

12/31/20Y6 12/31/20Y5

Liabilities $90,250 $87,000 Stockholders’ equity 60,000 67,000

chapter 1 introduction to accounting and business … · chapter 1 introduction to accounting and...

Documents