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Unformatted text preview: CHAPTER 2 DISCUSSION QUESTIONS 1. Investors, creditors, and other external users need to know a company's financial status. For example, what assets does the company own? Are the assets still productive? How hard would it be to sell the assets, if needed? Also, what debts must be paid? Are the owners' interests in the business increasing or decreasing and why? External users also need information on the profitability of the company. Is the company making or losing money? In addition, external users need to know what the total inflows and outflows of cash are—those from operations as well as those from investing and financing activities. This information is provided in the primary financial statements consisting of a balance sheet, an income statement, and a statement of cash flows. 2. a. A balance sheet shows a company's financial status (the relationships among assets, liabilities, and owners' equity) at a particular date. b. An income statement shows the results of an entity's operations during a period of time. c. A statement of cash flows shows the major inflows and outflows of cash during a period of time. 3. The answer might seem obvious to you, but you would be surprised at how often people get so caught up in dreaming of the “guaranteed” return that they forget to research the company's financial situation before investing. Would you buy a home on your friends' advice without seeing the home yourself? No, you would view the home and most likely hire an inspector to check it for problems before deciding if it would be a good investment. Just as you would inspect a home before investing, so should you inspect the company by, among other things, reviewing the financial statements. By researching the past and current financial statements of the company, you can determine (1) if past and present stock performances are indicative of the projected 150% return; (2) if the company has a history of positive or negative cash flows; (3) if sales have been steadily increasing or decreasing over time; and (4) if the company historically has had net earnings or losses. These are but a few of the many reasons why it is important to do the research yourself before immediately jumping into an investment just on your friends' advice. 4. Readers of annual reports need to compare the financial status and results of operations of a company with other companies and with the same company's results for previous periods. In this way, users can judge the relative progress of a company toward its goals. Statements covering more than one accounting period and those statements that classify and highlight key relationships assist in this comparative analysis. 5. There are three ways that economic resources can be brought into a business: borrowing from others, owner contributions, and earnings. The first is a liability, whereas the latter two are included in the owners' equity section. Together these two balance sheet sections (liabilities and owners' equity) inform readers of the “sources'' of assets.inform readers of the “sources'' of assets....
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- Fall '07
- Balance Sheet, ........., Generally Accepted Accounting Principles