SOLUTION MANUAL FOR ll ll
Fundamentals of Financial Accounting 7e Phillips ll l l ll ll ll
Chapter1-13 withAppendixC&D l ll l l
Chapter 1 l ll
BusinessDecisions andFinancial Accounting
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ANSWERS TO QUESTIONS l l
1. Accounting is a system of analyzing, recording, and summarizing the results of a l ll ll ll ll ll ll ll ll ll l ll ll
business‘s activities and then reporting them to decision makers. ll ll ll ll ll ll ll ll ll
2. An advantage of operating as a sole proprietorship, rather than a corporation, is that it is easy
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to establish. Another advantage is that income from a sole proprietorship is taxed only once in
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the hands of the individual proprietor (income from a corporation is taxed in the corporation
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and then again in the hands of the individual shareholder). A disadvantage of operating as a
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sole proprietorship, rather than a corporation, is that the individual proprietor can be held
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responsible for the debts of the business.
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3. Financial accounting focuses on preparing and using the financial statements that are made
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available to owners and external users such as customers, creditors, and potential investors who
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are interested in reading them. Managerial accounting focuses on other accounting reports that
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are not released to the general public, but instead are prepared for internal decision making
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and used by employees, supervisors, and managers who run the company.
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4. Financial reports are used by both internal and external groups and individuals. The internal
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groups are comprised of the various managers of the business. The external groups include
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investors, creditors, governmental agencies, other interested parties, and the public at large.
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5. The business itself, not the individual stockholders who own the business, is viewed as owning the
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assets and owing the liabilities on its balance sheet. A business‘s balance sheet includes the
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assets, liabilities, and stockholders‘ equity of only that business and not the personal assets,
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liabilities, and equity of the stockholders. The financial statements of a company show the
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results of the business activities of only that company.
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Fundamentals of Financial l l 1-1
Accounting, 7/e
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,6. (a) Operating – These activities are directly related to earning profits. They include buying
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supplies, making products, serving customers, cleaning the premises, advertising, renting a
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building, repairing equipment, and obtaining insurance coverage.
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(b) Investing – These activities involve buying and selling productive resources with long lives ll ll ll ll ll ll ll ll ll ll l l ll
(such as buildings, land, equipment, and tools), purchasing investments, and lending to
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others.
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(c) Financing–Anyborrowingfrombanks,repayingbankloans,receiving contributionsfrom l l l l l l l l l l l l
stockholders,orpayingdividendstostockholdersareconsidered financingactivities.
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7. The heading of each of the four primary financial statements should include the following:
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(a) Name of the business ll ll ll ll
(b) Name of the statement ll ll ll ll
(c) Date of the statement, or the period of time that the statement covers ll ll ll l ll ll ll ll ll ll ll ll ll
8. (a) The purpose of the balance sheet is to report the financial position (assets, liabilities
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and stockholders‘ equity) of a business at a point in time.
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(b) The purpose of the income statement is to present information about the l l l l l l l l l l l l l l l l l l l l l l
revenues, expenses, and net income of a business for a specified period of time.
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(c) The statement of retained earnings reports the way that net income and the l l l l l l l l l l l l l l l l l l l l l l l l
distribution of dividends affected the financial position of the company during the
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period.
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(d) The purpose of the statement of cash flows is to summarize how a business‘s ll ll ll ll ll ll ll ll ll ll ll ll ll
operating, investing, and financing activities caused its cash balance to change
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over a particular period of time.
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9. The income statement, statement of retained earnings, and statement of cash flows would be
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dated ―For the Year Ended December 31, 2021,‖ because they report the inflows and
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outflows of resources over a period of time. In contrast, the balance sheet would be dated
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―At December 31, 2021,‖ because it represents the assets, liabilities and stockholders‘
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equity at a specific date.
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10. Net income is the excess of total revenues over total expenses. A net loss occurs if total
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expenses exceed total revenues.
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11. The accounting equation for the balance sheet is: Assets = Liabilities + Stockholders‘ Equity.
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Assets are the economic resources controlled by the company. Liabilities are amounts owed
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by the business. Stockholders‘ equity is the owners‘ claims to the business. It includes amounts
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contributed to the business (by investors through purchasing the company‘s stock) and the
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amounts earned and accumulated through profitable business operations.
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Fundamentals of Financial l l 1-2
Accounting, 7/e
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,12. The equation for the income statement is Revenues – Expenses = Net Income. Revenues are
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increases in a company‘s resources, arising primarily from its operating activities. Expenses
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are decreases in a company‘s resources, arising primarily from its operating activities. Net
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Income is equal to revenues minus expenses. (If expenses are greater than revenues, the
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company has a Net Loss.)
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13. The equation for the statement of retained earnings is: Beginning Retained Earnings + Net
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Income - Dividends = Ending Retained Earnings. It begins with beginning-of-the-year retained
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earnings which is the prior year‘s ending retained earnings reported on the prior year‘s balance
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sheet. The current year's net income reported on the income statement is added and the current
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year's dividends are subtracted from this amount. (If a net loss occurs, It would be subtracted,
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along with the dividends, from the prior year‘s ending retained earnings balance.)The ending
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retained earnings amount is reported on the end-of-year balance sheet. 14. The equation
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for the statement of cash flows is: Cash flows from operating activities + Cash flows from
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investing activities + Cash flows from financing activities = Change in cash for the period.
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Change in cash for the period + Beginning cash balance = Ending cash balance. The net cash
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flows for the period represent the increase or decrease in cash that occurred during the period.
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Cash flows from operating activities are cash flows directly related to earning income (normal
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business activity). Cash flows from investing activities include cash flows that are related to the
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acquisition or sale of the company‘s long-term assets. Cash flows from financing activities are
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directly related to the financing of the company.
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15. Currently, the Financial Accounting Standards Board (FASB) is given the primary responsibility ll ll ll ll ll ll ll ll ll ll l l
for setting the detailed rules that become Generally Accepted Accounting Principles (GAAP)
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in the United States. (Internationally, the International Accounting Standards Board (IASB) has
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the responsibility for setting accounting rules known as International Financial Reporting
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Standards (IFRS).)
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16. The main goal of accounting rules is to ensure that companies produce useful financial
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information for present and potential investors, lenders, and other creditors
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decisions in their capacity as capital providers. Financial information must show relevance and
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faithful representation, as well as be comparable, verifiable, timely, and understandable.
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Fundamentals of Financial l l 1-3
Accounting, 7/e
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, 17. An ethical dilemma is a situation where following one moral principle would result in violating
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another. Three steps that should be considered when evaluating ethical dilemmas are:
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(a) Identify who will benefit from the situation (often, the manager or employee) and how ll ll ll ll ll ll ll ll ll ll ll ll l l
others will be harmed (other employees, the company‘s reputation, owners, creditors, and the
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public in general).
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(b) Identifythe alternative courses of action. l l l ll ll ll
(c) Choose the alternative that is the most ethical –that which you would be proud to have ll ll ll ll ll ll ll ll l ll ll ll ll ll l l ll
reported in the news media. Often, there is no one right answer and hard choices will need to
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be made. Following strong ethical practices is a key part of ensuring good financial reporting
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by businesses of all sizes.
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18. Accounting frauds and cases involving academic dishonesty are similar in many respects. Both ll ll ll ll ll ll ll ll ll ll l l ll
involve deceiving others in an attempt to influence their actions or decisions, often resulting in
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temporary personal gain for the deceiver. For example, when an accounting fraud is
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committed, financial statement users may be misled into making decisions they wouldn‘t have
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made had the fraud not occurred (e.g., creditors might loan money to the company, investors
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might invest in the company, or stockholders might reward top managers with big bonuses).
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When academic dishonesty is committed, instructors might assign a higher grade than is
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warranted by the student‘s individual contribution. Another similarity is that, as a consequence
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of the deception, innocent bystanders may be adversely affected by fraud and academic
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dishonesty. Fraud may require the company to charge higher prices to customers to cover costs
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incurred as a result of the fraud. Academic dishonesty may lead to stricter grading standards,
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with significant deductions taken for inadequate documentation of sources referenced. A final
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similarity is that if fraud and academic dishonesty are ultimately uncovered, both are likely to
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lead to adverse long-term consequences for the perpetrator. Fraudsters may be fined,
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imprisoned, and encounter an abrupt end to their careers. Students who cheat may be
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penalized through lower course grades or expulsion, and might find it impossible to obtain
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academic references for employment applications.
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Fundamentals of Financial l l 1-4
Accounting, 7/e
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