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, SOLUTION MANUAL FOR b b
Financial Accounting 11th Edition Robert Libby,
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Patricia Libby, Frank Hodge
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Chapter 1 b
Financial Statements and Business Decisions b b b b
ANSWERS TO QUESTIONS b b
1. Accounting is a system that collects and processes (analyzes, measures, and
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records) financial information about an organization and reports that information to
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decision makers.
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2. Financial accounting involves preparation of the four basic financial statements and
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related disclosures for external decision makers. Managerial accounting involves
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the preparation of detailed plans, budgets, forecasts, and performance reports for
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internal decision makers.
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3. Financial reports are used by both internal and external groups and individuals. The
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internal groups are comprised of the various managers of the entity. The external
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groups include the owners, investors, creditors, governmental agencies, other
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interested parties, and the public at large.
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4. Investors purchase all or part of a business and hope to gain by receiving part of
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what the company earns and/or selling their ownership interest in the company in
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the future at a higher price than they paid. Creditors lend money to a company
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for a specific length of time and hope to gain by charging interest on the loan.
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, 5. In a society, each organization can be defined as a separate accounting entity. An
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accounting entity is the organization for which financial data are to be collected.
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Typical accounting entities are a business, a church, a governmental unit, a
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university and other nonprofit organizations such as a hospital and a welfare
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organization. A business typically is defined and treated as a separate entity
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because the owners, creditors, investors, and other interested parties need to
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evaluate its performance and its potential separately from other entities and from its
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owners.
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6. Name of Statementb b Alternative Title b
(a) Income Statement b (a) Statement of Earnings; Statement of
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Income; Statement of Operations b b b b
(b) Balance Sheet b (b) Statement of Financial Position
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(c) Cash Flow Statement b b (c) Statement of Cash Flows
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7. The heading of each of the four required financial statements should include the
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following:
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(a) Name of the entity b b b b
(b) Name of the statement b b b b
(c) Date of the statement, or the period of time
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(d) Unit of measure b b b
8. (a) The purpose of the income statement is to present information about the
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revenues, expenses, and the net income of an entity for a specified period of
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time.
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(b) The purpose of the balance sheet is to report the financial position of an entity
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at a given date, that is, to report information about the assets, liabilities and
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stockholders’ equity of the entity as of a specific date.
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(c) The purpose of the statement of cash flows is to present information about the
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flow of cash into the entity (sources), the flow of cash out of the entity (uses),
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and the net increase or decrease in cash during the period.
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(d) The statement of stockholders’ equity reports the changes in each of the
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company’s stockholders’ equity accounts during the accounting period,
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including issue and repurchase of stock and the way that net income and
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distribution of dividends affected the retained earnings of the company during
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that period.
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9. The income statement and the statement of cash flows are dated ―For the Year
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Ended December 31‖ because they report the inflows and outflows of resources
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during a period of time. In contrast, the balance sheet is dated ―At December
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31‖because it represents the resources, obligations, and stockholders’ equity at
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a specific date.
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, 10. Assets are important to creditors and investors because assets provide a basis for
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judging whether sufficient resources are available to operate the company. Assets
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are also important because they could be sold for cash in the event the company
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goes out of business. Liabilities are important to creditors and investors because
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the company must be able to generate sufficient cash from operations or further
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borrowing to meet the payments required by debt agreements. If a business does
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not pay its creditors, the law may give the creditors the right to force the sale of
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assets sufficient to meet their claims.
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11. Net income is the excess of total revenues over total expenses. Net loss is the
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excess of total expenses over total revenues.
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12. The equation for the income statement is Revenues - Expenses = Net Income (or
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Net Loss if the amount is negative). Thus, the three major items reported on the
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income statement are (1) revenues, (2) expenses, and (3) net income.
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13. The equation for the balance sheet (also known as the basic accounting equation)
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is: Assets = Liabilities + Stockholders’ Equity. Assets are the probable (expected)
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future economic benefits owned by the entity as a result of past transactions. They
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are the resources owned by the business at a given point in time such as cash,
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receivables, inventory, machinery, buildings, land, and patents. Liabilities are
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probable (expected) debts or obligations of the entity as a result of past
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transactions that will be paid with assets or services in the future. They are the
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obligations of the entity such as accounts payable, notes payable, and bonds
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payable. Stockholders’ equity is financing provided by owners of the business and
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operations. It is the claim of the owners to the assets of the business after the
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creditors’ claims have been satisfied. It may be thought of as the residual interest
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because it represents assets minus liabilities.
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14. The equation for the statement of cash flows is: Cash flows from operating activities
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+ Cash flows from investing activities + Cash flows from financing activities =
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Change in cash for the period. The net cash flows for the period represent the
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increase or decrease in cash that occurred during the period. Cash flows from
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operating activities are cash flows directly related to earning income (normal
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business activity including interest paid and income taxes paid). Cash flows from
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investing activities include cash flows that are related to the acquisition or sale of
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productive assets used by the company. Cash flows from financing activities are
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directly related to the financing of the enterprise itself.
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15. The retained earnings equation is: Beginning Retained Earnings + Net Income -
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Dividends = Ending Retained Earnings. It begins with beginning-of-the-year
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Retained Earnings which is the prior year’s ending retained earnings reported on
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the balance sheet. The current year's Net Income reported on the income
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statement is added and the current year's Dividends are subtracted from this
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amount. The ending Retained Earnings amount is reported on the end-of-period
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balance sheet.
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