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Unformatted text preview: CHAPTER 2 2-1 The operating cycle depends on the nature of the company. It is the time it takes the company to use cash to acquire goods and services, to sell those goods and services to customers, and to collect cash from the sales. 2-2 A fiscal year is the year used for financial reporting. It may be the same as a calendar year, but often it is not. Many companies elect to begin and end a fiscal year at the low point in their annual business activity. 2-3 The cash basis fails to match accomplishments with efforts. In particular, the cash basis fails to match revenues and expenses properly. Inventory may be bought and paid for in one period, sold in the second with the collection from customers in a third period. Accrual accounting matches revenue and cost of goods sold in the second period, although the cash outlay was in the first and the collection was in the third. 2-4 Expenses are reductions in stockholders' equity; thus they may be accurately described as negative stockholders' equity accounts. 2-5 The two tests of revenue recognition are earning and realization. 2-6 Revenue recognition is delayed when a company sells a magazine subscription because revenue is not recognized until it is earned by delivery of the magazines. Revenue recognition is also delayed if collection of the account receivable is not reasonably certain, which may happen with speculative land sales. Chapter 2 Measuring Income to Assess Performance 31 2-7 In theory, all expenses are goods and services that were first purchased as assets and that have now been utilized (used up) in the conduct of operations. 2-8 Managers acquire assets (goods and services) that are then either used instantaneously or at a later time. When the assets are used, they become expenses. 2-9 The balance sheet is a financial picture of a company at one point in time, like a snapshot. In contrast, an income statement shows activity over a period of time. It shows the series of events that take a company from one snapshot (balance sheet) to another, just as a moving picture shows movement from one position to the next. 2-10 Synonyms for the income statement are statement of earnings, statement of operations, and profit and loss (P&L) statement. A major reason to learn accounting is to be able to read real financial statements. Such statements contain a variety of terms that may differ from the one first leaned in an introductory accounting course. To be able to read and interpret the financial statements, users need to understand the terminology used, including synonyms used for the major accounting terms. 2-11 Managers are often optimistic and feel that things are bound to get better, so they do not like to report bad news. In addition, they may have bonuses or possible future promotions that depend on the financial reports, so they want the reports to be as good as possible. Finally, financial reports are often the scorecard for business success, and competitive managers want to report a high score....
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- Spring '10