Chapter 17 – Understanding Accounting and Financial Information
76. Many businesses now use computers and accounting software to simplify the mechanical
aspects involved in accounting.
77. Accounting software for small businesses has become so sophisticated that most small
business owners will never need to consult with an actual accountant or understand
accounting information themselves.
78. Accounting software has proven to be especially helpful for small business owners.
79. Carol has worked as a bookkeeper for a small clothing store for almost three years. Her
old boss recently retired and a new manager took over. The new manager frequently asks
her for information and advice about how to interpret the information she records.
Carol’s experience as a bookkeeper means she is qualified to provide this type of advice.
Feedback: Bookkeepers typically handle the part of the accounting cycle that involves
recording information about business transactions. Bookkeepers do not normally have the
training and experience needed to analyze and interpret this information. That job is generally
left to accountants.
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83. Olivia is a public accountant. She prepares monthly financial statements for her client,
Chick’s Auto Body Shop. Presently, though, she must summarize the data in the
accounting ledgers to determine if the figures are correct and balanced. Olivia will
prepare a statement of cash flows in order to complete this step of the cycle.
Feedback: Olivia is at the step of the cycle where she should prepare a trial balance. The
purpose of a trial balance is to summarize all the data in the ledger accounts to determine if
the figures are correct and balanced. A statement of cash flows is a financial statement
prepared in the fifth stage of the accounting cycle.
84. Mike is the head of the accounting department at Micro flash. After completing the trial
balance, he will proceed with the preparation of the balance sheet, the income statement
and the statement of cash flows.
Feedback: After the trial balance is completed, the accounting cycle moves to the preparation
and analysis of the key financial statements: The balance sheet, income statement, and
statement of cash flows.
85.
Chapter 17 – Understanding Accounting and Financial Information
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In addition to the tasks of recording and classifying accounting information, the best
accounting software programs currently available for small businesses have the ability to
make financial decisions, thus eliminating the need for owners of small businesses to
consult with accountants or understand accounting terminology.
Feedback: No computer software program yet has the ability to make good financial decisions
by itself. A trained, experienced accountant is still needed to assist a firm in achieving its
financial goals.
86. Juliet has found that her small business needs a better way to maintain accounting
87.
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The steps in the accounting cycle do not need to be followed in the order stated. Monthly
financial statements can be prepared with a good amount of accuracy, prior to posting in
the ledger or preparing the trail balance.
Feedback: Financial statements rely on the accurate posting in the ledger, and the checks
provided by the trial balance. Financial statements cannot be verified for accuracy if the
proper entries are not transferred to the ledger, and into the appropriate accounts.
88. Courtney McRae started the Row-Your-Boat paddle boat and row boat business at a
nearby lake resort. She wanted to combine her accounting degree with her love of the
outdoors and fishing. One of her first business purchases was a computerized accounting
system. She learned in her college classes that a good software system will eliminate
accounting cycle steps and the time it takes for her to interpret the results. As she put it,
“It should make the decisions for me!”
Feedback: A good computerized accounting system will not replace the need for the decision-
making skills of an accountant.
89. The key financial statements are the balance sheet, the income statement, and the
statement of cash flows.
90.
Chapter 17 – Understanding Accounting and Financial Information
The income statement reports the difference between a firm’s assets and its liabilities as
of a certain date.
91. A firm’s balance sheet reports its financial condition on a specific date.
92. The balance sheet reports revenues and selling costs for a period of time.
93. An income statement reports what a company owns and owes on a certain day.
94. Assets are reported on the firm’s balance sheet.
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105. General expenses include office salaries, rent, and insurance.
106. Net income before taxes is found by deducting total operating expenses from gross
profit.
107. A statement of cash flows summarizes a company’s cash receipts and cash payments
over a period of time.
108. Cash flow statements identify three sources of cash receipts and disbursements: Assets,
liabilities and owners’ equity.
109.
Chapter 17 – Understanding Accounting and Financial Information
The statement of cash flows calculates cash flows from operations, investing activities,
and financing activities.
110. An analysis of the statement of cash flows can help a firm prevent cash shortages.
111. The statement of cash flows shows a firm’s revenues, costs of goods sold, expenses, and
net income.
112. The equipment a firm owns and the money it has in its bank account are considered
assets.
Feedback: Firm’s hold current assets and fixed assets. Cash, accounts receivable, and
inventory are examples of current assets. Property and equipment are examples of fixed
assets. Typically, fixed assets have an estimated useful life, whereas current assets are used-
up with a year’s time.
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117. Liquidity refers to how quickly liabilities must be paid.
Feedback: Liquidity is a term applied to a firm’s assets. Liabilities are debts owed by the firm.
118. Net income is simply the difference between revenue and cost of goods sold.
Feedback: Revenues – cost of goods sold = gross profit. Net income represents the “bottom
line” of the Income statement.
119.
Chapter 17 – Understanding Accounting and Financial Information
The cost of goods sold reflects the selling price of the merchandise sold over a period of
time.
Feedback: The cost of goods sold reflects the price that a firm paid for merchandise that it
plans to resell; or the price of raw materials that a firm paid for in order to produce a good or
service for resale. Revenues = Selling Price X Volume.
120. The cash a firm raised from issuing new debt or equity capital would be reported on a
statement of cash flows.
Feedback: Cash received or disbursed through financing activities are recorded on the
statement of cash flows.
121. The Barkley Company’s balance sheet shows: what the business owns, minus what the
business owes, equals the book value (or, net worth) of the business.
Feedback: Assets [what the firm owns], minus liabilities [what the firm owes], = the owners’
equity [its net worth].
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122. One important source of financing for most small businesses is the owners savings. If the
owner contributes money to the business from his/her personal savings, it will be
recorded in the Owner’s Equity account on the balance sheet.
Feedback: Two important sources of financing for businesses are borrowed funds (liabilities)
and contributed funds (owners’ equity).
123. The Barkley Company has recorded its unpaid bill for supplies under a current liabilities
account on the balance sheet. This payment will be due to the supplier in less than a
year.
Feedback: Current liabilities are debts that are due in less than one year.
124. The Barkley Company wants to know the value of its owners’ equity. It will total its
assets and subtract its liabilities.
Feedback: Assets – liabilities = owners’ equity
125.
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The Barkley Company balance sheet shows the following items: Accounts payable
totaling $50,000; salaries payable totaling $65,000, and notes payable totaling $100,000.
These are liabilities, or money that the firm owes others.
Feedback: Also known as debt, liabilities are obligations the firm owes others.
126. The “bottom line” of the Barkley Company’s income statement is equal to the net worth
of the firm.
Feedback: The “bottom line” of an income statement shows net profit (or net loss) after taxes
are paid. The balance sheet will reflect the “net worth” of the firm.
127. The Barkley Company will refer to its income statements to determine whether it was
profitable, or, whether it lost money over the past year.
Feedback: The “bottom line” of the income statement shows profits (or net losses) over a
period of time.
128.
Chapter 17 – Understanding Accounting and Financial Information
The income statement computes net income by subtracting liabilities from assets.
Feedback: The income statement records revenues and then subtracts all expenses (including
taxes) in order to calculate net income.
129. Revenue on the income statement represents the dollar amount of what is received for
goods sold, services rendered and/or from other revenue sources.
Feedback: Revenues constitute sales from goods sold and/or services rendered, as well as
monies received from other sources such as rent income or interest income from marketable
securities.
130. The Barkley Company has several automobiles that are used in the business. Recently,
the owners were told that even though the government permits the firm to depreciate the
vehicles, it is not a deductible expense on the income statement.
Feedback: Depreciation is a legitimate expense on the Income Statement.
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134. FIFO is a method of computing net cash flows by subtracting financial inflows from
financial outflows.
Feedback: FIFO [first-in; first-out] is an inventory valuation method used for computing the
cost of goods sold on an income statement.
135. FIFO is a method of inventory valuation that assumes the items most recently purchased
are also the items that are sold first.
Feedback: FIFO [first-in; first-out] assumes that the oldest items in inventory are sold first.
136. The LIFO method of inventory valuation assumes the newest items in inventory are sold
first.
Feedback: LIFO [last-in; first-out] assumes that the newest items in inventory are sold first.
137.
Chapter 17 – Understanding Accounting and Financial Information
According to generally accepted accounting principles (GAAP), a firm must use the
inventory valuation method that most accurately reflects the actual movement of goods
through its inventory.
Feedback: GAAP does not concern itself with the movement of goods through a firm’s
inventory system. It is concerned with a firm choosing a method of valuation and consistently
using that method.
138. Banks are likely to request a firm’s balance sheet when determining whether or not to
loan money to the firm. However, banks would have little interest in the firm’s income
statement since it covers a short period of time.
Feedback: Both the income statement and the balance sheet are important in evaluating the
financial health of an organization. Specifically, the income statement would show the firm’s
ability to generate the profits with which to pay back a loan.
139. Harrison Manufacturing owns land worth $600,000 and has $130,000 worth of cash in
its bank account. In the asset section of the balance sheet, Harrison lists its land holdings
prior to listing its cash since it is a higher value.
Feedback: A balance sheet lists assets in order of liquidity—i.e., how easily and quickly they
can be converted into cash. The most liquid assets are called current assets, and they are listed
first on the balance sheet. Obviously, cash is the most liquid asset of all. Land is not
considered a liquid asset because it usually takes a significant amount of time and paperwork
to sell it and collect the cash proceeds.
