Financial Statements Paper 1

"Answer (B) is correct. According to the FASB’s Conceptual Framework, the objectives of external financial reporting are to provide information that (1) is useful to present and potential investors, creditors, and others in making rational financial decisions regarding the enterprise; (2) helps those parties in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from sale, redemption, or maturity of securities or loans; and (3) concerns the economic resources of an enterprise, the claims thereto, and the effects of transactions, events, and circumstances that change its resources and claims thereto."

"Answer (D) is correct. Financial statement notes should not be used to correct improper presentations. The financial statements should be presented correctly on their own. Notes should be used to explain the methods used to prepare the financial statements and the amounts shown. The first footnote typically describes significant accounting policies."

Answer (C) is correct. A statement of cash flows provides information about the cash receipts and cash payments of an entity during a period. This information helps investors, creditors, and other users to assess the entity’s ability to generate cash and cash equivalents and the needs of the entity to use those cash flows. Historical cash flow data indicate the amount, timing, and certainty of future cash flows. It is also a means of verifying past cash flow assessments and of determining the relationship between profits and net cash flows and the effects of changing prices.

Answer (A) is correct. The future inflow of economic benefits is not sufficiently certain given that the entity has not done what is required to be entitled to those benefits. Thus, the receipt of cash in anticipation of goods to be delivered or services to be performed must be recognized as a liability, usually called deferred (or unearned) revenue or deferred (or unearned) income.

Answer (D) is correct. Managerial accounting assists management decision making, planning, and control. Financial accounting addresses accounting for an entity’s assets, liabilities, revenues, expenses, and other elements of financial statements. Financial statements are the primary method of communicating to external parties information about the entity’s results of operations, financial position, and cash flows. For general-purpose financial statements to be useful to external parties, they must be prepared in conformity with accounting principles that are generally accepted in the United States. However, managerial accounting information is primarily directed to specific internal users. Hence, it ordinarily need not follow such guidance.

Answer (D) is correct. Accrual-basis amounts used in financial reporting are not useful to managers making day-to-day operating decisions. The practice of management accounting fulfills the needs of these users.

Answer (D) is correct. The balance sheet presents three major financial accounting elements: assets (items of value), liabilities (debts), and equity (net worth). According to the FASB Conceptual Framework, assets are probable future economic benefits resulting from past transactions or events. Liabilities are probable future sacrifices of economic benefits arising from present obligations as a result of past transactions or events. Equity is the residual interest in the assets after deduction of liabilities.

Answer (D) is correct. Prepaid expenses, such as supplies, prepaid rent, and prepaid insurance, are reported on the balance sheet at cost minus the expired or used portion. These are typically current assets.

Answer (C) is correct. Available-for-sale securities (an investment) and prepaid expenses are assets, but treasury stock is an equity item. The total of the assets reported is therefore $600,000 ($200,000 + $400,000).

Answer (C) is correct. The equation is based on the proprietary theory. Equity in an enterprise is what remains after the economic obligations of the enterprise are deducted from its economic resources.