Chapter 1 They have obtained advance approval for a one-year loan at

Document Type
Test Prep
Book Title
Financial Accounting: A Bridge to Decision Making 6th Edition
Authors
Robert W. Ingram, Thomas L. Albright
34 Chapter 1
11. Steve & Laura have identified a great business idea to make money at the 2007 International
Festival. They have obtained advance approval for a one-year loan at 12% for $8,000. In addition,
they will invest $20,000 of their own money. They estimate their profit for 2007 will look like the
following:
Steve & Laura Company
Projected Statement of Profits
For the Year 2007
Resources created from products sold
$150,000
Resources consumed:
Cost of the goods sold
$25,000
Advertising
11,200
Rent
10,000
Wages
8,000
Insurance
2,000
Utilities
3,000
Interest
960
60,160
Profit
$ 89,840
Required:
Assume Steve & Laura's business plan works out exactly as estimated. After completion of the
festival, they will liquidate the company.
a.
What is the dollar amount of Steve & Laura's:
1. return on investment
2. return of investment
b.
What is the percentage return on investment to those providing the loan?
c.
Assume Steve & Laura can save the rent by using their garage at home. What would be
their percentage return on investment then?
Accounting and Organizations 35
ESSAY
1. How does accounting help stakeholders of a business make decisions about the business?
2. Your next-door neighbor asks "What is accounting?" Having just read and studied chapter one of
your accounting textbook, you are unusually well prepared to respond. Do so.
3. Business organizations can generally be classified as being retail (or merchandising),
manufacturing, or service organizations.
Required:
Complete each of the sections below. Do not use any company or organization more than once.
a.
Give an example of at least one well-known organization in your community for each
of these three categories. Clearly label which organization fits which classification.
b.
Give one example of an organization in your community that is both a manufacturing
and a service company. Explain what the firm does that qualifies it for each category.
c.
Give one example of an organization in your community that is both a manufacturing
company and a retailing company. Explain what the firm does that qualifies it for each
category.
36 Chapter 1
4. What is the transformation process and how is the accounting function related to it?
5. Your authors point out that the transformation process creates value. First, explain what the
transformation process is and, second, describe and discuss how it creates value.
Accounting and Organizations 37
6. It is sometimes said that the purpose of organizations is to create value. Describe the process by
which organizations create value.
7. Two companies are identical in every respect except for their pattern of profits. Given below are the
firm's profit reports for the past seven years. (All numbers are in millions of dollars.)
2004
2005
2006
2007
2008
2009
2010
8
9
10
9
7
12
10
26
(4)
12
36
4
(26)
20
Required:
a.
Explain the concept of risk vs. return.
b.
Which firm would you recommend someone invest in. (You might recommend
neither, both, or one or the other.) Explain your reasoning.
38 Chapter 1
8. Given below is the profit history of two firms over the last seven years. The companies are identical
in every respect except for their patterns of net income. All numbers are in thousands of dollars. As
is common with financial data, the most recent year is listed first.
2010
2009
2008
2007
2006
2005
2004
Andean Corp.
224
262
170
208
226
207
182
Harris, Inc.
226
(229)
266
381
434
(18)
287
Required:
a.
Explain the concept of risk vs. return.
b.
Which firm would you recommend someone invest in? (You might recommend
neither, both, or one or the other.) Explain your reasoning.
9. Define return on investment and explain what useful information that calculation provides someone
interested in a company.
Accounting and Organizations 39
10. You and three of your friends are considering forming a company and must decide if the company
will be a partnership or a corporation. Since you have recently learned about the ownership
structures of companies in your financial accounting course, your friends ask you to describe three
reasons for and three reasons against becoming a corporation. What would you tell them? Briefly
explain each reason.
11. You are listening to two of your classmates studying for an upcoming accounting test. One says,
"The professor is sure to ask us about 'effectiveness' and 'efficiency' of businesses." The other
student replies, "My uncle's company made over a million dollars last year. It must be both effective
and efficient. After all, how could a business be effective without being efficient?"
Required:
Clarify for your two friends the difference between an effective organization and an efficient one.
Give examples to help clarify your answer.
40 Chapter 1
12. Explain the concept of "moral hazard." Give an example of how a manager might find himself or
herself involved in this situation. In addition, identify an example of how moral hazard might face
someone not in a business firm (e.g., a professor, or a politician).
Accounting and Organizations 41
13. What is the concept of "moral hazard"? Give an example and explain why it is a problem for
corporations but not for proprietorships and partnerships.
14. Companies are involved in contracts with many other entities. Name three different categories of
people or organizations with which a company would be likely to be contracting. Define each
category and indicate how accounting information about the company helps members of that
category.
42 Chapter 1
15. What is a contract and how can accounting information be useful when a contract exists? Give two
examples of a contract for which accounting information would be beneficial.
Accounting and Organizations 43
16. Discuss the concepts of risk and return and identify any relationship that might exist between them.
17. Briefly tell the difference between managerial accounting and financial accounting.
44 Chapter 1
18. The terms GAAP, audit, and CPA are interrelated. Define and describe each term and discuss their
interrelationship.
19. Define the term "financial accounting" and give three specific examples of who would use it and for
what purpose.
Accounting and Organizations 45
20. Define the term "managerial accounting" and give three specific examples of how it would be used
in decision making.
21. If companies were not required to have an annual audit, how might investors and creditors decisions
be impacted?

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