Financial Accounting, 8ce, Libby, Libby, Hodge, Kanaan, Sterling © 2023 McGraw-Hill Limited. All rights reserved. 1-1 Chapter 1 Financial Statements and Business Decisions Revised: August 5, 2022 ANSWERS TO QUESTIONS 1. Accounting is a system that collects and processes (analyzes, measures, and records) financial information about an organization and reports that information to decision makers. 2. Financial accounting involves preparation of the basic financial statements and related disclosures for external decision makers. Reporting is generally on a quarterly and annual basis. Managerial accounting involves the preparation of detailed plans, budgets, forecasts, and performance reports for internal decision makers. Reporting is on an ongoing basis. 3. Financial reports are used by both internal and external groups and individuals. The internal users are the various managers of the entity, e.g. marketing, credit , and purchasing. The external groups include the owners, investors, creditors, governmental agencies, other interested parties, and the public at large. 4. Investors purchase all or part of a business and hope to gain by receiving part of what the company earns and/or by selling their share of the company in the future at a higher price than they paid. Creditors lend money to a company for a specific length of time and hope to gain by charging interest on the loan. 5. An accounting entity is the organization for which financial data are to be collected. Typical accounting entities are a business, a church, a governmental unit, a university , and other nonprofit organizations such as a hospital. A business is defined and treated as a separate entity because the owners, creditors, investors, and other interested parties need to evaluate its performance and its potential separately from other entities and from its owners. 6. Name of Statement Alternative Title a. Statement of earnings Income statement b. Statement of financial position Balance sheet c. Statement of cash flows Cash flow statement 7. The heading of each of the four required financial state ments should include the following: (a) Name of the entity (b) Title of the statement (c) Specific date or the period of time it covers (d) Unit of measure (Financial Accounting, 8th Canadian Edition, 8e Robert Libby, Patricia Libby, Frank Hodge, George Kanaan, Maureen Sterling)
(Solution Manual, For Complete File, Download link at the end of this File) Financial Accounting, 8ce, Libby, Libby, Hodge , Kanaan, Sterling © 202 3 McGraw -Hill Limited. All rights reserved. 1-2 8. (a) The purpose of the statement of earnings is to present information about the revenues, e xpenses, and the net earnings of the entity for a specified period of time, in order to help assess its financial performance during that period. (b) The purpose of the statement of financial position is to report the financial position of an entity at a given date, that is, to report information about the assets, obligations , and shareholders’ equity of the entity as at a specific date. (c) The statement of changes in equity reports the way that net earnings, the distribution of net earnings (dividends), and other changes to shareholders’ equity affected the company’s financial position during the accounting period. The focus in this chapter is on retained earnings. Net earnings for the year increases the balance of retained earnings whereas t he declaration of dividends to the shareholders decreases retained earnings. (d) The purpose of the statement of cash flows is to present information about the flow of cash into the entity (sources), the flow of cash out of the entity (uses), and the net increase or decrease in cash during the period. 9. The statement of earnings and the statement of cash flows are dated “For the Year Ended December 31” because they report the inflows and outflows of resources during a period of time. In contrast, the sta tement of financial position is dated “ At December 31” because it represents the resources, obligations , and shareholders’ equity as at a specific date, December 31. 10. Assets are important to investors and creditors because assets provide a basis for ju dging whether sufficient resources are available to operate the company. Liabilities are important to creditors and investors because the company must be able to generate sufficient cash from operations or seek further borrowing to meet the payments requir ed by debt agreements. If a business does not pay its creditors, the law may give the creditors the right to force the sale of assets sufficient to meet the creditors’ claims. 11. Net earnings is the excess of total revenues over total expenses. Net loss is the excess of total expenses over total revenues. 12. The accounting equation for the statement of earnings is Revenues – Expenses = Net earnings. Revenues result from the sale of goods and services to customers, regardless of the timing of collection of cash from customers. Expenses represent the monetary value of resources the entity used up, or consumed, to earn revenues during the period. Net earnings is simply the excess of revenues over expenses. Financial Accounting, 8ce, Libby, Libby, Hodge , Kanaan, Sterling © 202 3 McGraw -Hill Limited. All rights reserved. 1-3 13. The accounting equation for the statement of financial position is: Assets = Liabilities + Shareholders’ Equity Assets are the probable (expected) future economic benefits owned by the entity as a result of past transactions. They are the resources owned by the business at a given po int in time such as cash, accounts receivable, merchandise inventory, machinery, buildings, land, and patents. Liabilities are probable (expected) debts or obligations of the entity as a result of past transactions that will be discharged with assets (usua lly cash) or services in the future. They are the obligations of the entity such as accounts payable and notes payable. Shareholders’ equity is financing provided by owners of the business and by the net earnings generated from the operations of the busine ss. It is the claim of the owners to the assets of the business after the creditor s’ claims have been satisfied. Shareholders’ equity may be thought of as the residual interest because it represents assets minus liabilities. 14. The accounting equation f or retained earnings is: Beginning retained earnings + Net earnings – Dividends = Ending retained earnings The equation begins with beginning -of-the-year retained earnings , i.e., the prior year’s ending retained earnings reported on the statement o f financial position. The current year's net earnings reported on the statement of earnings is added to this amount and the dividends declared during the current year are subtracted from this amount. The ending retained earnings amount is reported on the end-of-period statement of financial position. 15. The accounting equation for the statement of cash flows is: Cash flows from operating activities +/– Cash flows from investing activities +/– Cash flows from financing activities = Change in cash for the period. The net cash flows for the period represent the increase or decrease in cash that occurred during the period. Cash flows from operating activities are cash flows directly related to earning income (normal business activity including interest paid and income taxes paid). Cash flows from investing activities comprise cash flows that are directly related to the acquisition or sale of productive assets used by the company, such as plant and equipment. Cash flow s from financing activities consist of cash flows that are directly related to the financing of the enterprise, such as issuing shares to investors. Financial Accounting, 8ce, Libby, Libby, Hodge , Kanaan, Sterling © 202 3 McGraw -Hill Limited. All rights reserved. 1-4 16. Credit managers use customers' financial statements to decide whether to extend them credit for their purchases. Purchasing managers use potential suppliers' financial statements to judge whether the suppliers have the resources necessary to meet current and future demand. Human resource managers use the financial statements as a basis for contract negotia tions to determine, for example, what pay rates the company can afford. The net earnings figure can also serve as a basis to pay bonuses not only to management, but to other employees through profit -sharing plans. 17. In Canada, provincial securities legi slation created securities commissions, most notably the Ontario Securities Commission (OSC) , to regulate Canadian capital markets and the flow of financial information provided by publicly traded companies whose shares trade on Canadian stock exchanges, s uch as the Toronto Stock Exchange. Similar to the SEC, the OSC plays an influential role in promoting sound accounting practices by publicly traded companies. Since their establishment, these securities commissions have worked with organizations of profes sional accountants to establish groups that are given the primary responsibilities to work out the detailed rules that Canadian entities must use. The name of the current Canadian group that has this responsibility is the Accounting Standards Board (AcSB) . The AcSB is responsible for establishing standards of accounting and reporting by Canadian companies and not -for-profit organizations. 18. The officers of the company, usually the C hief Executive Officer and the C hief Financial Officer , must personally sign a certification that they have designed or supervised the design, implementation , and evaluation of effective, appropriate financial accounting and reporting processes. The executives and officers of the company bear primary responsibility for information prepared and reported in the financial statements and other information contained in the annual report. Top management also nominates members to the Board of Directors to oversee the integrity of the first two safeguards. Those owning share s of the firm vote to elect the Board of Directors , which holds the officers of the company accountable to the shareholders for defects in the internal control and reporting system. It also appoints external, independent auditors who provide advice to com panies on how to best comply with regulations on financial reporting. 19. A sole proprietorship is an unincorporated business owned by one individual. A partnership is an unincorporated association of two or more individuals to carry on a business. A corporation is a business that is organized under federal or provincial laws, whereby a charter is granted and the entity is thus authorized to issue shares as evidence of ownership by the owners (i.e., shareholders). Corporations are legal entities separate from their owners, but sole proprietorships and partnerships are not.
