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AC221 Libby & Short Ch. 02~Solutions~

AC221 Libby & Short Ch. 02~Solutions~ - Chapter 02...

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Chapter 02 - Investing and Financing Decisions and the Balance Sheet Chapter 02 Investing and Financing Decisions and the Balance Sheet ANSWERS TO QUESTIONS 1. The primary objective of financial reporting for external users is to provide useful economic information about a business to help external parties, primarily investors and creditors, make sound financial decisions. These users are expected to have a reasonable understanding of accounting concepts and procedures. Usually, they are interested in information to assist them in projecting future cash inflows and outflows of a business. 2. (a) An asset is a probable future economic benefit owned by the entity as a result of past transactions. (b) A current asset is an asset that will be used or turned into cash within one year; inventory is always considered a current asset regardless of how long it takes to produce and sell the inventory. (c) A liability is a probable debt or obligation of the entity as a result of a past transaction, which will be paid with assets or services. (d) A current liability is a liability that will be paid in cash (or other current assets) or satisfied by providing service within the coming year. (e) Contributed capital is the financing provided to the business by owners; usually owners provide cash and sometimes other assets such as equipment and buildings. (f) Retained earnings are the cumulative earnings of a company that are not distributed to the owners and are reinvested in the business. 2-1
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Chapter 02 Investing and Financing Decisions and the Balance Sheet 3. (a) The separate-entity assumption requires that business transactions are separate from the transactions of the owners. For example, the purchase of a truck by the owner for personal use is not recorded as an asset of the business. (b) The unit-of-measure assumption requires information to be reported in the national monetary unit. That means that each business will account for and report its financial results primarily in terms of the national monetary unit, such as Yen in Japan and Australian dollars in Australia. (c) Under the continuity or going-concern assumption, businesses are assumed to operate into the foreseeable future. That is, they are not expected to liquidate. (d) The historical cost principle requires assets to be recorded at the cash- equivalent cost on the date of the transaction. Cash-equivalent cost is the cash paid plus the dollar value of all noncash considerations. 4. Accounting assumptions are necessary because they reflect the scope of accounting and the expectations that set certain limits on the way accounting information is reported. 5. An account is a standardized format used by organizations to accumulate the dollar effects of transactions on each financial statement item. Accounts are necessary to keep track of all increases and decreases in the fundamental accounting model.
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