Ch 03 - CHAPTER 3 REVIEW OF FINANCIAL STATEMENTS ANSWERS TO...

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CHAPTER 3 REVIEW OF FINANCIAL STATEMENTS ANSWERS TO END OF CHAPTER QUESTIONS: 1. The four types of statements found in the typical annual report are the balance sheet , the income statement , the statement of retained earnings , and the statement of cash flows. The balance sheet provides a snapshot of the firm’s financial condition as of a particular date. It shows what the firm owns (assets) and how they were financed between liabilities and stockholders’ equity. The income statement shows the operating results of the firm over a period of time. It details the earnings generated by the firm after all expenses have been subtracted from the expenses. The statement of retained earnings reconciles the retained earnings number in the balance sheet with the net income figure from the income statement. The statement of cash flows shows the effects of a company’s operating, investing, and financing activities on its cash balance. 2. The primary reason why net income is not the same as the cash generated by the firm is because the income statement (and the balance sheet) is based on accrual accounting. In other words, revenues and expenses are recorded when incurred—not when cash changes hands. For example, if raw materials are purchased and paid for, they are not recognized as an expense until the product is sold although the cash balance reflects the payment for the purchase. 3. a. Total assets. Sum of all the assets owned by the firm. b. Current assets. Cash and other assets that are likely to be converted to cash in the near term, typically defined as less than one year. c. Fixed assets. Long-term assets that are used in the business such as property, plant, and equipment. d. Current liabilities. Obligations of the firm that have to be settled in the short term, usually less than one year. e. Accounts payable. Money owed by the firm as a result of purchasing goods and services from a supplier on credit. f. Accrued expenses. These are expenses or liabilities that have been incurred but not yet paid for. For example, accrued interest expense is the interest expense incurred on a debt obligation since the last payment but has not yet been paid because interest payment is due, say, once every six months. g. Accounts receivable. The funds owed to the company by a customer. This arises because merchandise/service may be sold on credit terms. h. Inventory. Refers to raw materials, work in process, and finished goods that have not been sold yet. i. Deferred income taxes. Deferred income taxes arise because of “temporary” differences in the income reported to shareholders and income reported for tax purposes. j. Shareholders’ equity. Represents the ownership interest in the firm and consists of preferred stock and common stock ownership interests.
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