Chapter 1 Introduction to Accounting and Business Study Guide. Do You Know?

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1 Chapter 1 Introduction to Accounting and Business Study Guide Do You Know? Learning Objective 1: Describe the nature of a 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: Summarize the development of accounting principles and relate them to practice. The characteristics of each type of business entity? (See exercises 7 9) The different concepts used in accounting? (See exercises 10 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 6: 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) 1

2 2 Chapter 1 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

3 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 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 corporation and partnership d. Combines resources and skills of two or more individuals 8. 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. 9. 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.

4 4 Chapter Determine the accounting concept 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. Amounts are initially recorded in the accounting ledgers at their cost or purchase price. c. Amounts should be recorded based on objective evidence. 11. Which accounting concept do the following characteristics define? a. Economic data should be recorded in dollars. b. Expenses should be shown with the same revenues that the expenses produced. c. An accountant should only use the information related to the company, regardless of the industry benchmark amounts. 12. Which accounting concept 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 to the purchase order. c. Although some expenses were paid by year-end, the company s income statement only included the amounts incurred for the year. 13. If a business has the following balances, how much is total liabilities? Assets Liabilities Cash $ 5,000 Accounts receivable 2,575 Total liabilities? Equipment 14,000 Stockholders Equity Common stock & additional paid in capital $ 700 Retained earnings 1, 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?

5 Introduction to Accounting and Business 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. 18. Apple Tree had the following balances when formed: Assets Liabilities Cash $2,400 Notes Payable $1,500 Equipment 1,300 Stockholders Equity Common stock 2,200 Total assets $3,700 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.

6 6 Chapter 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, 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, Rental revenue of $15,000 Wages expense of $3,500 Rental expense of $5,300 Miscellaneous expense of $1, Create World Co. s retained earnings statement using net income 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.

7 Introduction to Accounting and Business 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, 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 Issuance of common stock for $1,500 Cash payments for expenses of $10,000 Cash received from notes payable of $1,800 Purchase of new equipment $3,300 Cash dividends to stockholders $2, If the following transactions occurred for the year June 30, 2015, 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 Miscellaneous expense of $4,300 Interest expense of $1,200 Wages expense of $4, Using the net income 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.

8 8 Chapter Create Purple Sun s balance sheet using the amounts found in Exercise 27 and the following account balances: Property, plant, and equipment: $18,800 Cash: $6,400 Accounts payable: $3,300 Investments in securities: $1,500 Common stock: $3, 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 $6,000 long-term note payable to the seller Cash received from customers $20,000 Issuance of common stock for $2,300 cash Cash dividends to shareholders $6,200 Cash payments for expenses $7, With the following transactions, create Polka Dot s income statement for the year ended September 30, Interest revenue of $23,000 Interest expense of $14,000 Rent expense of $4,000 Legal expense of $1,400 Wages expense of $3,200 Miscellaneous expense of $2, 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 and information from Exercise 30.

9 Introduction to Accounting and Business Using the ending retained earnings balance from Exercise 31, create Polka Dot s balance sheet. The company had the ending account balances below: Cash: $3,250 Investment in securities: $22,000 Notes payable: $19,500 Property, plant, and equipment: $5,000 Interest payable: $4,200 Accounts payable: $4,500 Common stock: $1, 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 expenses $17,300 Cash dividends $1,000 Cash paid for new building $5,000 Cash received from customers $12, 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,

10 10 Chapter 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 owners are more or less at risk. 12/31/ /31/2015 Liabilities 15,000 14,750 Stockholders Equity 14,800 14, 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/ /31/2015 Liabilities 90,250 87,000 Stockholders Equity 60,000 67,000

Chapter 1 Introduction to Accounting and Business Study Guide. Do You Know?

Chapter 1 Introduction to Accounting and Business Study Guide Do You Know? Learning Objective 1: Describe the nature of a business and the role of accounting and ethics in business. How to distinguish