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ch02 homework solutions - CHAPTER 2 DISCUSSION QUESTIONS 1...

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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 product- ive? How hard would it be to sell the assets, if needed? Also, what debts must be paid? Are the owners' interests in the business in- creasing or decreasing and why? External users also need information on the profitabil- ity of the company. Is the company making or losing money? In addition, external users need to know what the total inflows and out- flows 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 fin- ancial 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 dur- ing 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 “guaran- teed” return that they forget to research the company's financial situation before invest- ing. Would you buy a home on your friends' ad- vice 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 invest- ment. Just as you would inspect a home be- fore investing, so should you inspect the company by, among other things, reviewing the financial statements. By researching the past and current finan- cial statements of the company, you can de- termine (1) if past and present stock per- formances are indicative of the projected 150% return; (2) if the company has a his- tory of positive or negative cash flows; (3) if sales have been steadily increasing or de- creasing 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 your- self before immediately jumping into an in- vestment 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 rel- ative progress of a company toward its goals. Statements covering more than one accounting period and those statements that classify and highlight key relationships as- sist in this comparative analysis. 5. There are three ways that economic re- sources can be brought into a business: bor- rowing 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) in- form readers of the “sources'' of assets.
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