Chapter 1: Introduction to Financial Statements

What is the objective of the Income Statement?

To measure the success of a business over a period of time by reporting revenues and expenses.

What does the Retained Earnings Statement show?

How much net income was retained in the business and how much was distributed as dividends during a period of time.

What is the objective of the Balance Sheet?

To provide a snapshot at a point in time of what a business owns (assets) and owes (liabilities) and owners’ equity.

What is the objective of the Statement of Cash Flows?

To show where cash came from and how it was used, categorized into operating, investing, and financing activities.

What is the accounting equation?

Assets = Liabilities + Stockholders’ (Owner’s) Equity

How can the accounting equation be rearranged algebraically?

• Assets − Liabilities = Equity

• Assets − Equity = Liabilities

What comprises stockholders’ equity?

Common stock + Retained earnings

Define assets.

things of value owned by a business.

Define liabilities.

debts and obligations 

Define retained earnings.

profit that was “retained” by the business; in other words, not paid out to the owners 

Define dividends and where are they reported?

a portion of corporate profits paid to shareholders, reported on the Retained Earnings Statement, not the Income Statement.

Define revenues and where are they reported?

Amounts earned from selling goods or services; reported on the Income Statement.

Define expenses and where are they reported?

Costs incurred to generate revenue; reported on the Income Statement.

What is the correct order of preparing financial statements and why?

• Income Statement (net income needed next)

• Retained Earnings Statement (uses net income)

• Balance Sheet (uses ending retained earnings)

• Statement of Cash Flows (uses balance sheet and income data)

What are the three types of business activities?

Operating, Investing, and Financing

What is a financing activity?

Activities related to raising money, such as issuing stock, borrowing money, or paying dividends.

What is an investing activity?

Buying or selling long-term assets like equipment, buildings, or investments.

What is an operating activity?

Day-to-day business activities like selling goods, paying wages, and incurring expenses.

What are accounts payable?

Amounts owed to suppliers for purchases made on credit (a liability).

What are accounts receivable?

Amounts owed to the business by customers from credit sales (an asset).

What are the key characteristics of a corporation?

Separate legal entity, limited liability, transferable ownership, easier to raise capital, higher taxes, unlimited life.

How does a corporation differ from a sole proprietorship?

Corporations are separate legal entities with limited liability; sole proprietorships are not separate and have unlimited personal risk.

How does a corporation differ from a partnership?

Corporations offer limited liability and ownership transferability; partnerships share risk and are not separate legal entities.

What is an LLC or LLP?

A hybrid entity offering liability protection with fewer legal requirements and flexible tax treatment.

What is an S corporation?

A corporation that avoids double taxation by passing income directly to owners.

What is the formula for ending retained earnings?

Beginning Retained Earnings + Net Income − Dividends

Who are internal users of financial information?

Managers and employees who use information to run the business.

Who are external users of financial information?

Investors, creditors, banks, and regulators who use information to make decisions about the company.

Which of the following consists of external users?

Investors and regulatory agencies

Net income will result during a time period when

revenues exceed expenses.

Which of the following financial statements is prepared as of a specific point in time?

Balance sheet

Which of the following may increase a starting salary about 10 to 15% more in a public accounting firm above the averages given in the chapter?

A CPA license