Guided Readings for Financial Accounting, Lesson 3.2 – Mastery Level
SUGGESTION: Read the fourth section of Chapter Three (“Reporting a Balance Sheet and a Statement of Cash Flows”). This section looks at the last two financial statements. Note the example of a balance sheet shown in Table 3.6. These terms and this structure should begin to make sense to you. Note that the balance sheet does balance (the asset total is the same as the liability and stockholders’ equity total). In Table 3.7, the statement of cash flows appears and shows the inflows and outflows of cash during the year (classified into three distinct categories).
(3Q23) – An income statement and a statement of retained earnings cover a period of time such as the “year ended December 31, Year Six.” How is a balance sheet dated?
(3A23) – A balance sheet reports one specific point in time. It is a portrait of the assets and liabilities at one precise moment. For example, a balance sheet might be dated “as of December 31, Year Six.” All of the other financial statements cover a period of time, but a balance sheet is created to report the last moment of time in that period.
(3Q24) – Why does a balance sheet balance?
(3A24) – On a balance sheet, the stockholders’ equity section exists to explain the origin of a company’s net assets. The net asset figure is calculated by subtracting liabilities from assets. As long as this difference is completely explained by the stockholders’ equity section, its total will equal assets minus liabilities. The balance sheet stays in balance because of the explanatory role played by stockholders’ equity. It is always equal to the difference between assets and liabilities because it is the explanation of that difference.
(3Q25) – In producing a balance sheet, some assets are listed as current assets and some as noncurrent assets. You can see that separation in Table 3.6 in the textbook. What is the difference in a current asset and a noncurrent asset?
(3A25) – Current assets are those that are expected to be used or consumed within one year. Thus, cash, inventory, accounts receivable, supplies, prepaid expenses and the like are all listed as current assets. Assets that are not expected to be used or consumed within one year are labeled as noncurrent assets. This category includes land, buildings, equipment, patents and the like. Separate reporting helps decision makers evaluate the future prospects and financial health of the company.
Near “The Accounting Equation” in Section 3.4, watch the video titled, Six Basic Questions about Financial Accounting and Reporting. This video will enable you to make certain that you are learning an appropriate amount about the material in this chapter.
(3Q26) – What are current liabilities? What are noncurrent liabilities?
(3A26) – Current liabilities are debts expected to be paid within one year from the balance sheet date. Noncurrent liabilities are not expected to be paid within one year.
(3Q27) – People studying an organization’s financial statements often compute its current ratio and the amount of working capital. How are these two computations made?
(3A27) – The current ratio is calculated by dividing an organization’s current assets by its current liabilities. Working capital is found by subtracting an organization’s current liabilities from its current assets. Both figures serve as indications of the short-term financial strength of the reporting entity. These figures help a decision maker determine how easily an organization can meet its debts as they come due.
The following statement is from the end of chapter material in the textbook. The answer is false.
Explain why this statement is false. (You might want to look back at Table 3.6 in the chapter and consider how the collection of a $20,000 receivable affects the reported balances.)
The Bagranoff Company has a current ratio of 3:1. The company collects a $20,000 account receivable. The current ratio will rise as a result of this collection.
The previous statement is false. The current ratio is 3:1 which means that the reporting company (Bagranoff) has three times as many current assets as it has current liabilities. Cash of $20,000 is then collected. Cash (a current asset) goes up whereas accounts receivable (another current asset) goes down. Hence, the total of the current assets stays the same. The increase and decrease offset. Current liabilities are not affected. The current ratio remains at 3:1.
(3Q28) – What are the three sections of a statement of cash flows?
(3A28) – As shown in Table 3.7, a statement of cash flows is made up of the following sections:
--Operating activities—shows cash changes from the normal day-to-day operations of the business.
--Investing activities—shows cash changes from activities that are not part of the day-to-day operations of the business but involve assets.
--Financing activities—shows cash changes from activities that are not part of the day-to-day operations of the business but involve either liabilities or stockholders’ equity
(3Q29) – Donut Delights Company is producing a set of financial statements. On the statement of cash flows, three sections are presented: operating activities, investing activities, and financing activities.
Give examples of cash changes that might fall within each of these three categories for this company.
(3A29) – Operating activities for a donut shop are likely to include: cash received from selling donuts, cash paid to employees, and cash paid for rent. These events (and many others) relate to day-to-day operations.
--Investing activities might include: cash received from selling a delivery truck and cash paid to acquire a new stove or refrigerator.
--Financing activities might include: distribution of a cash dividend, borrowing money from a bank, and issuing capital stock to a new owner.
SUGGESTION: Work the second Test Yourself question in Section 3.4 of Chapter Three (“In reviewing a statement of cash flow…”). This problem is designed to make sure you understand which type of events go into each of the three sections on a statement of cash flows. Notice that three of these statements are true but only one is not true. That is the answer you are seeking.
Near “Classification of Cash Flows” in Section 3.4, watch the video titled, Where Are Account Balances Reported and What Do They Mean?
This video provides an excellent overview of major account balances and how they are reported in a set of financial statements.