The Chapter Preview describes the purpose of the chapter and highlights major topics.
If you own a business, how do you determine whether it is making or losing money? How should you finance expansion—should you borrow, should you issue stock, should you use your own funds? How do you convince banks to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require financial information.
The purpose of this chapter is to show you what role accounting plays in providing financial information.
The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business.
Many students who take this course do not plan to be accountants. If you are in that group, you might be thinking, “If I’m not going to be an accountant, why do I need to know accounting?” Well, consider this quote from Harold Geneen, the former chairman of IT&T: “To be good at your business, you have to know the numbers—cold.” In business, accounting financial statements are the means for communicating the numbers. If you don’t know how to read financial statements, you can’t really know your business.
Knowing the numbers is sometimes even a matter of corporate survival. Consider the story of Columbia Sportswear Company, headquartered in Portland, Oregon. Gert Boyle’s family fled Nazi Germany when she was 13 years old and then purchased a small hat company in Oregon, Columbia Hat Company. In 1971, Gert’s husband, who was then running the company, died suddenly. Gert took over the small, struggling company with help from her son Tim, who was then a senior at the University of Oregon. Somehow, they kept the company afloat. Today, Columbia has more than 4,000 employees and annual sales in excess of $1 billion. Its brands include Columbia, Mountain Hardwear, Sorel, and Montrail.
Employers such as Columbia Sportswear generally assume that managers in all areas of the company are “financially literate.” To help prepare you for that, in this text you will learn how to read and prepare financial statements, and how to use key tools to evaluate financial results using basic data analytics.
The Chapter Outline presents the chapter’s topics and subtopics, as well as practice opportunities.
LEARNING OBJECTIVES | REVIEW | PRACTICE |
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LO 1 Identify the forms of business organization and the uses of accounting information. |
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DO IT! 1a Business Organization Forms 1b Using Financial Information |
LO 2 Explain the three principal types of business activity. |
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DO IT! 2 Business Activities |
LO 3 Describe the four financial statements and how they are prepared. |
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DO IT! 3a Financial Statements: Parts 1–4 3b Components of Annual Reports |
Go to the Review and Practice section at the end of the chapter for a targeted summary and practice applications with solutions. Visit Wiley Course Resources for additional tutorials and practice opportunities. |
Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You enjoy working with people, especially teaching them new skills. You spend most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking. You think you might successfully combine your teaching skills and outdoor interest by starting an outdoor guide service.
What organizational form should you choose for your business? You have three choices—sole proprietorship, partnership, or corporation.
You might choose the sole proprietorship form for your outdoor guide service.
Small owner-operated businesses such as barber shops, law offices, and auto repair shops are often sole proprietorships, as are farms and small retail stores.
Another possibility is for you to join forces with other individuals to form a partnership.
You and your partners should formalize your duties and contributions in a written partnership agreement. Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certified public accountants), often organize as partnerships.
As a third alternative, you might organize as a corporation.
Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or partnership interest is much more involved. Also, individuals can become stockholders by investing relatively small amounts of money (see Alternative Terminology).
Alternative Terminology notes present synonymous terms that you may come across in practice.
Therefore, it is easier for corporations to raise funds compared to sole proprietorships or partnerships. Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange. Many businesses start as sole proprietorships or partnerships and eventually incorporate.
Other factors to consider in deciding which organizational form to choose are taxes and legal liability. Sole proprietorships or partnerships, generally receive more favorable tax treatment than corporations. However, proprietors and partners are personally liable for all debts and legal obligations of the business; corporate stockholders are not. In other words, corporate stockholders generally pay higher taxes but have no personal legal liability. We will discuss these issues in more depth in a later chapter.
Finally, while sole proprietorships, partnerships, and corporations represent the main types of business organizations, hybrid forms are now allowed in all states.
The combined number of proprietorships and partnerships in the United States far exceeds the number of corporations. However, the revenue produced by corporations is many times greater. Most of the largest businesses in the United States—for example, Apple, Google, Verizon, Visa, and Microsoft—are corporations. Because the majority of U.S. business is done by corporations, the emphasis in this text is on the corporate form of organization.
DO IT! exercises prompt you to stop and review the key points you have just studied. The Action Plan offers you tips about how to approach the problem.
The purpose of financial information is to provide inputs for decision-making.
Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, managers must answer many important questions, as shown in Illustration 1.1.
ILLUSTRATION 1.1 Questions that internal users ask
To answer these and other questions, you need detailed information on a timely basis. For internal users, accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. In addition, companies present summarized financial information in the form of financial statements.
Accounting Across the Organization boxes show applications of accounting information in various business functions.
There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors, such as suppliers and bankers, use accounting information to evaluate the risks of selling on credit or lending money. Some questions that investors and creditors may ask about a company are shown in Illustration 1.2.
ILLUSTRATION 1.2 Questions that external users ask
The information needs and questions of other external users vary considerably.
For example, Enron, Dynegy, Duke Energy, and other big energy-trading companies reported record profits at the same time as California was paying extremely high prices for energy and suffering from blackouts. This disparity caused regulators to investigate the energy traders to make sure that the profits were earned by legitimate and fair practices.
Accounting software systems collect vast amounts of data about a company’s economic events as well as its suppliers and customers. Business decision-makers take advantage of this wealth of data by using data analytics to gain insights and therefore make more informed business decisions.
Helpful Hints further clarify concepts being discussed.
Illustration 1.3 shows the four most common types of data analytics that help answer questions ranging from what happened and why did it happen, to what is likely to happen and what should we do about it? Analytics range from simple analysis that can be performed using spreadsheets with tools like pivot tables and graphs, to complex statistical software and even artificial intelligence. More complex analysis provides greater value to the business.
ILLUSTRATION 1.3 Four types of data analytics
Insight boxes provide examples of business situations from various perspectives—ethics, investor, international, corporate social responsibility, and data analytics.
People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t “play” the stock market if they think stock prices are rigged. At one time, major financial scandals at Enron, WorldCom, HealthSouth, and AIG led to a mistrust of financial reporting in general.
A Wall Street Journal article noted that “repeated disclosures about questionable accounting practices have bruised investors’ faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared. Information would have no credibility. A well-functioning economy depends on accurate and reliable financial reporting.
U.S. regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting.
Ethics Notes help sensitize you to some of the ethical issues in accounting.
Effective financial reporting depends on sound ethical behavior. When analyzing ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1.4.
ILLUSTRATION 1.4 Steps in analyzing ethics cases
Businesses engage in three types of activity—financing, investing, and operating. For example, consider Gert Boyle’s parents, the founders of Columbia Sportswear.
The accounting information system keeps track of the results of each of the various business activities—financing, investing, and operating. Let’s look at each type of business activity in more detail.
It takes money to make money. Financing activities involve raising money from outside sources. The two primary sources of outside funds for corporations are borrowing money (debt financing) and issuing (selling) shares of stock in exchange for cash (equity financing).
Columbia Sportswear may borrow money in a variety of ways. For example, it can take out a loan at a bank or borrow directly from investors by issuing debt securities called bonds. Persons or entities to whom Columbia owes money are its creditors.
Corporations also obtain funds by selling shares of stock to investors. Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase.
The claims of creditors differ from those of stockholders. If you loan money to a company, you are one of its creditors. In lending money, you specify a payment schedule (e.g., payment at the end of three months). As a creditor, you have a legal right to be paid at the agreed time. In the event of nonpayment, you may legally force the company to sell property to pay its debts. In the case of financial difficulty, creditor claims must be paid before stockholders’ claims.
Stockholders, on the other hand, have no claim to corporate cash until the claims of creditors are satisfied. Suppose you buy a company’s stock instead of loaning it money. You have no legal right to expect any payments from your stock ownership until all of the company’s creditors are paid amounts currently due. However, many corporations make payments to stockholders on a regular basis as long as there is sufficient cash to cover required payments to creditors. These cash payments to stockholders are called dividends.
Once the company has raised cash through financing activities, it uses that cash in investing activities. Investing activities involve the purchase of the resources a company needs in order to operate. Resources owned by a business are called assets. A growing company purchases many assets, such as computers, delivery trucks, furniture, and buildings.
Once a business has the assets it needs to get started, it begins operating activities. Operating activities are the day-to-day actions taken by a company to produce and sell a product, or provide a service. Columbia Sportswear is in the business of selling outdoor clothing and footwear. It sells TurboDown jackets, Millennium snowboard pants, Sorel® snow boots, Bugaboots™, rainwear, and anything else you might need to protect you from the elements. We call amounts earned from the sale of these products revenues.
The company purchases its longer-lived assets through investing activities as described earlier. Other assets with shorter lives, however, result from operating activities.
Before Columbia can sell a single Sorel® boot, it must purchase wool, rubber, leather, metal lace loops, laces, and other materials. It then must process, wrap, and ship the finished product. It also incurs costs like salaries, rents, and utilities. All of these costs, referred to as expenses, are necessary to produce and sell the product.
For example, Columbia keeps track of these types of expenses: cost of goods sold (such as the cost of materials), selling expenses (such as the cost of salespersons’ salaries), marketing expenses (such as the cost of advertising), administrative expenses (such as the salaries of administrative staff, and telephone and heating costs incurred at the corporate office), interest expense (amounts of interest paid on various debts), and income tax expense (corporate taxes paid to the government).
Columbia may also have liabilities arising from these expenses.
Columbia compares the revenues of a period with the expenses of that period to determine whether it earned a profit. When revenues exceed expenses, net income results. When expenses exceed revenues, a net loss results.
Assets, liabilities, expenses, and revenues are of interest to users of accounting information. This information is arranged in the format of four different financial statements, which form the backbone of financial accounting:
To introduce you to these statements, we have prepared the financial statements for your outdoor guide service, Sierra Corporation, after your first month of operations (see International Note).
International Notes highlight differences between U.S. and international accounting standards.
To summarize, you officially started your business in Truckee, California, on October 1, 2025. Sierra provides guide services in the Lake Tahoe area of the Sierra Nevada mountains. Its promotional materials describe outdoor day trips, such as rafting, snowshoeing, and hiking, as well as multi-day backcountry experiences. To minimize your initial investment, your customers either bring their own equipment or rent equipment through local outfitters. The financial statements for Sierra’s first month of business are provided in the following pages.
The income statement reports a company’s revenues and expenses and resulting net income or loss for a period of time (see Decision Tools). To indicate that its income statement reports the results of operations for a specific period of time, Sierra Corporation dates the income statement “For the Month Ended October 31, 2025.” The income statement lists the company’s revenues followed by its expenses. Finally, Sierra determines the net income (or net loss) by deducting expenses from revenues. Sierra’s income statement is shown in Illustration 1.5 (see Helpful Hint). Congratulations, you are already showing a profit!
Decision Tools that are useful for business decision-making are highlighted throughout the text. A summary of the Decision Tools is also provided in each chapter.
ILLUSTRATION 1.5 Sierra Corporation’s income statement
Sierra Corporation Income Statement For the Month Ended October 31, 2025 |
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Revenues | ||||
Service revenue | $10,600 | |||
Expenses | ||||
Salaries and wages expense | $5,200 | |||
Supplies expense | 1,500 | |||
Rent expense | 900 | |||
Interest expense | 50 | |||
Insurance expense | 50 | |||
Depreciation expense | 40 | |||
Total expenses | 7,740 | |||
Net income | $ 2,860 | |||
Why are financial statement users interested in net income?
Thus, reporting a strong profit will make it easier for Sierra to raise additional cash either by issuing shares of stock or borrowing.
Amounts received from issuing stock are not revenues, and amounts paid out as dividends are not expenses. As a result, they are not reported on the income statement. For example, Sierra Corporation does not treat as revenue the $10,000 of cash received from issuing new stock (see Illustration 1.8), nor does it regard as a business expense the $500 of dividends paid (see Illustration 1.6) (see Ethics Note).
If Sierra Corporation is profitable, at the end of each period it must decide what portion of profits to pay to shareholders in dividends. In theory, it could pay all of its current-period profits, but few companies do this. Why? Because they want to retain part of the profits to allow for further expansion. High-growth companies, such as Google and Facebook, often pay no dividends. Retained earnings is the net income retained in the corporation.
The retained earnings statement shows the amounts and causes of changes in retained earnings for a specific time period (see Decision Tools). The time period is the same as that covered by the income statement. The beginning retained earnings amount appears on the first line of the statement. Then, the company adds net income and deducts dividends to determine the retained earnings at the end of the period. If a company has a net loss, it deducts (rather than adds) that amount in the retained earnings statement. Illustration 1.6 presents Sierra’s retained earnings statement (see Helpful Hint).
ILLUSTRATION 1.6 Sierra Corporation’s retained earnings statement
Sierra Corporation Retained Earnings Statement For the Month Ended October 31, 2025 |
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Retained earnings, October 1 | $0 | ||
Add: Net income | 2,860 | ||
2,860 | |||
Less: Dividends | 500 | ||
Retained earnings, October 31 | $2,360 | ||
By monitoring the retained earnings statement, financial statement users can evaluate dividend payment practices.
The balance sheet reports assets and claims to assets at a specific point in time (see Decision Tools). Claims to assets are subdivided into two categories: claims of creditors and claims of owners. As noted earlier, claims of creditors are called liabilities. The owners’ claim to assets is called stockholders’ equity.
Illustration 1.7 shows the relationship among the categories on the balance sheet in equation form.
ILLUSTRATION 1.7 Basic accounting equation
As you can see from looking at Sierra Corporation’s balance sheet in Illustration 1.8, the balance sheet presents the company’s financial position as of a specific date—in this case, October 31, 2025 (see Helpful Hint). It lists assets first. Assets are listed in the order of their liquidity, that is, how quickly they could be converted to cash.
Assets are followed by liabilities and stockholders’ equity (see Alternative Terminology). Stockholders’ equity is comprised of two parts: (1) common stock and (2) retained earnings. As noted earlier, common stock results when the company sells new shares of stock; retained earnings is the net income retained in the corporation. Sierra has common stock of $10,000 and retained earnings of $2,360, for total stockholders’ equity of $12,360.
ILLUSTRATION 1.8 Sierra Corporation’s balance sheet
Sierra Corporation Balance Sheet October 31, 2025 |
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Assets | ||||
Cash | $15,200 | |||
Accounts receivable | 200 | |||
Supplies | 1,000 | |||
Prepaid insurance | 550 | |||
Equipment, net | 4,960 | |||
Total assets | $21,910 | |||
Liabilities and Stockholders’ Equity | ||||
Liabilities | ||||
Notes payable | $ 5,000 | |||
Accounts payable | 2,500 | |||
Unearned service revenue | 800 | |||
Salaries and wages payable | 1,200 | |||
Interest payable | 50 | |||
Total liabilities | $ 9,550 | |||
Stockholders’ equity | ||||
Common stock | 10,000 | |||
Retained earnings | 2,360 | |||
Total stockholders’ equity | 12,360 | |||
Total liabilities and stockholders’ equity | $21,910 | |||
Creditors analyze a company’s balance sheet to determine the likelihood that they will be repaid.
The primary purpose of a statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time (see Decision Tools). To help investors, creditors, and others in their analysis of a company’s cash position, the statement of cash flows reports the cash effects of a company’s operating, investing, and financing activities. In addition, the statement shows the net increase or decrease in cash during the period, and the amount of cash at the end of the period.
Users are interested in the statement of cash flows because they want to know what is happening to a company’s most important resource. The statement of cash flows provides answers to these simple but important questions:
The statement of cash flows for Sierra Corporation, in Illustration 1.9, shows that cash increased $15,200 during the month (see Helpful Hint). This increase resulted because operating activities (services to clients) increased cash $5,700, and financing activities increased cash $14,500. Investing activities used $5,000 of cash for the purchase of equipment.
ILLUSTRATION 1.9 Sierra Corporation’s statement of cash flows
Sierra Corporation Statement of Cash Flows For the Month Ended October 31, 2025 |
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Cash flows from operating activities | ||||
Cash receipts from operating activities | $11,200 | |||
Cash payments for operating activities | (5,500) | |||
Net cash provided by operating activities | $ 5,700 | |||
Cash flows from investing activities | ||||
Purchased office equipment | (5,000) | |||
Net cash used by investing activities | (5,000) | |||
Cash flows from financing activities | ||||
Issuance of common stock | 10,000 | |||
Issuance of note payable | 5,000 | |||
Payment of dividend | (500) | |||
Net cash provided by financing activities | 14,500 | |||
Net increase in cash | 15,200 | |||
Cash at beginning of period | 0 | |||
Cash at end of period | $15,200 | |||
Illustration 1.10 shows the financial statements of Sierra Corporation (see Helpful Hints). Because the results on some financial statements become inputs to other statements, the statements are interrelated. These interrelationships can be seen in Sierra’s financial statements, as follows.
Study these interrelationships carefully. To prepare financial statements, you must understand the sequence in which these amounts are determined and how each statement impacts the next.
ILLUSTRATION 1.10 Sierra Corporation’s financial statements
Publicly traded U.S. companies must provide shareholders with an annual report. The annual report always includes the financial statements introduced in this chapter. The annual report also includes other important information such as a management discussion and analysis section, notes to the financial statements, and an independent auditor’s report. No analysis of a company’s financial situation and performance is complete without a review of these items.
The management discussion and analysis (MD&A) section presents management’s views on the company’s:
Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. A brief excerpt from the MD&A section of a recent Columbia Sportswear annual report, which addresses its liquidity requirements, is presented in Illustration 1.11.
ILLUSTRATION 1.11 Columbia Sportswear’s management discussion and analysis
Columbia Sportswear Company Management’s Discussion and Analysis of Seasonality and Variability of Business |
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Our business is affected by the general seasonal trends common to the industry, including discretionary consumer shopping and spending patterns, as well as seasonal weather. Our products are marketed on a seasonal basis, and our sales are weighted substantially toward the third and fourth quarters, while our operating costs are more equally distributed throughout the year. |
Explanatory notes and supporting schedules accompany every set of financial statements and are an integral part of the statements. The notes to the financial statements clarify the financial statements and provide additional detail. Information in the notes does not have to be quantifiable (numeric). Examples of notes are:
The notes are essential to understanding a company’s operating performance and financial position.
Illustration 1.12 is an excerpt from the notes to recent Columbia Sportswear financial statements. It describes the methods that the company uses to account for revenues.
ILLUSTRATION 1.12 Notes to Columbia Sportswear’s financial statements
Columbia Sportswear Company Notes to Financial Statements Revenue Recognition |
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Revenues are recognized when our performance obligations are satisfied as evidenced by transfer of control of promised goods to our customers, in an amount that reflects the consideration we expect to be entitled to receive in exchanges for those goods or services. Within our wholesale channel, control generally transfers to the customer upon shipment to, or upon receipt by, the customer depending on the terms of sale with the customer. Within our DTC channel, control generally transfers to the customer at the time of sale within our retail stores and concession-based arrangements and upon shipment to the customer with respect to e-commerce transactions. |
An auditor’s report is prepared by an independent outside auditor. It states the auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.
An auditor is an accounting professional who conducts an independent examination of a company’s financial statements. Only accountants who meet certain criteria and thereby attain the designation certified public accountant (CPA) may certify audits.
For example, Blockbuster once dominated movie rentals in the United States with over 9,000 stores. But it faltered when the upstart Netflix rapidly took over the movie-rental business. Blockbuster’s auditor then stated that its financial situation raised “substantial doubt about the Company’s ability to continue as a going concern.” Shortly after that, the company filed for bankruptcy.
Illustration 1.13 is an excerpt from the auditor’s report from Columbia Sportswear’s 2019 annual report. Columbia received an unqualified opinion from its auditor, Deloitte & Touche.
ILLUSTRATION 1.13 Excerpt from auditor’s report on Columbia Sportswear’s financial statements
Columbia Sportswear Company Excerpt from Auditor’s Report |
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We have audited the accompanying consolidated balance sheets of Columbia Sportswear Company and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. |
Using the Decision Tools comprehensive exercises ask you to apply business information and the decision tools presented in the chapter. Most of these exercises are based on the companies highlighted in the Feature Story.
Why is accounting such a popular major and career choice?
Accountants are in such demand that it is not uncommon for accounting students to have accepted a job offer a year before graduation. As Illustration 1A.1 reveals, the job options of people with accounting degrees are virtually unlimited.
ILLUSTRATION 1A.1 Career options in accounting
Areas of Accounting Careers | Type of Work | Examples of Employers | Certification Opportunities |
Public accounting |
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Deloitte, EY, KPMG, PwC, Grant Thornton, BDO, Baker Tilly | Certified public accountants (CPAs), enrolled agent (EA), certified information systems auditor (CISA) |
Private accounting |
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For-profit: Starbucks, Google, Under Armour Non-profit: Salvation Army, Red Cross | Certified management accountant (CMA), certified internal auditor (CIA) |
Governmental accounting |
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Internal Revenue Service (IRS), Federal Bureau of Investigation (FBI) | Certified government financial manager (CGFM) |
Forensic accounting |
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Insurance companies, law firms, FBI | Certified fraud examiner (CFE) |
How much can a new accountant make? Take a look at the average salaries for college graduates in public and private accounting shown in Illustration 1A.2.1 Keep in mind if you also have a CPA license, you’ll make 10–15% more when you start out.
ILLUSTRATION 1A.2 Salary estimates for jobs in public and corporate accounting
Employer | Jr. Level (0–3 yrs.) | Sr. Level (4–6 yrs.) |
Public accounting (large firm) | $63,250–$83,250 | $78,500–$106,500 |
Public accounting (medium firm) | $56,500–$67,750 | $70,500–$96,000 |
Public accounting (small company) | $51,500–$60,500 | $63,750–$81,500 |
Corporate accounting (large company) | $53,750–$69,500 | $68,750–$87,750 |
Illustration 1A.3 lists some examples of upper-level salaries for managers in corporate accounting. Note that geographic region, experience, education, CPA certification, and company size each play a role in determining salary.
ILLUSTRATION 1A.3 Upper-level management salaries in corporate accounting
Position | Large Company | Small to Medium Company |
Chief financial officer | $207,000–$465,750 | $105,250–$208,750 |
Corporate controller | $140,000–$224,750 | $92,000–$161,250 |
Tax manager | $112,000–$158,250 | $88,000–$124,750 |
The Review and Practice section provides opportunities for students to review key concepts and terms as well as complete multiple-choice questions, brief exercises, exercises, and a comprehensive problem. Detailed solutions are also included.
A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock.
Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to decide whether to buy, hold, or sell shares of a company’s stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies.
Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit.
An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders’ equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time.
Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders’ equity represents the claims of owners on the assets of the business. Stockholders’ equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity.
Within the annual report, the management discussion and analysis provides management’s interpretation of the company’s results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor’s report expresses an opinion as to whether the financial statements present fairly the company’s results of operations and financial position.
Accounting offers many different jobs in fields such as public and private accounting, governmental, and forensic accounting. Accounting is a popular major because there are many different types of jobs, with unlimited potential for career advancement.
Decision Checkpoints | Info Needed for Decision | Tool to Use for Decision | How to Evaluate Results |
Are the company’s operations profitable? | Income statement | The income statement reports a company’s revenues and expenses and resulting net income or loss for a period of time. | If the company’s revenues exceed its expenses, it will report net income; otherwise, it will report a net loss. |
What is the company’s policy toward dividends and growth? | Retained earnings statement | The retained earnings statement reports how much of this year’s income the company paid out in dividends to shareholders. | A company striving for rapid growth will pay a low (or no) dividend. |
Does the company rely primarily on debt or stockholders’ equity to finance its assets? | Balance sheet | The balance sheet reports the company’s resources and claims to those resources; there are two types of claims: liabilities and stockholders’ equity. | Compare the amount of debt versus the amount of stockholders’ equity to determine whether the company relies more on creditors or owners for its financing. |
Does the company generate sufficient cash from operations to fund its investing activities? | Statement of cash flows | The statement of cash flows shows the amount of net cash provided or used by operating activities, investing activities, and financing activities. | Compare the amount of net cash provided by operating activities with the amount of net cash used by investing activities. Any deficiency in cash from operating activities must be made up with cash from financing activities. |
1. (LO 1) Which is not one of the three forms of business organization?
b. Creditorship is not a form of business organization. The other choices are incorrect because (a) sole proprietorship, (c) partnership, and (d) corporation are all forms of business organization.
2. (LO 1) Which is an advantage of corporations relative to partnerships and sole proprietorships?
c. An advantage of corporations is that investors are not personally liable for debts of the business. The other choices are incorrect because (a) lower taxes, (b) harder to transfer ownership, and (d) most common form of organization are not true of corporations.
3. (LO 1) Which statement about users of accounting information is incorrect?
d. Regulatory authorities are considered external, not internal, users. The other choices are true statements.
4. (LO 1) Which of the following did not result from the Sarbanes-Oxley Act?
d. The Sarbanes-Oxley Act (SOX) was created to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals, not to address tax rates. The other choices are incorrect because (a) top management must now certify the accuracy of financial information, (b) penalties for fraudulent activity increased, and (c) increased independence of auditors all resulted from SOX.
5. (LO 2) Which is not one of the three primary business activities?
c. Advertising is a type of operating activity. The other choices are incorrect because (a) financing, (b) operating, and (d) investing are the three primary business activities.
6. (LO 2) Which of the following is an example of a financing activity?
a. Issuing shares of common stock is a financing activity. The other choices are incorrect because (b) selling goods on account is an operating activity, (c) buying delivery equipment is an investing activity, and (d) buying inventory is an operating activity.
7. (LO 2) Net income will result during a time period when:
d. When a company earns more revenues than expenses, it will report net income during a time period. The other choices are incorrect because (a) assets and liabilities are on the balance sheet, not the income statement; (b) assets are on the balance sheet, not the income statement; and (c) net income results when revenues exceed expenses, not when expenses exceed revenues.
8. (LO 3) The financial statements for Macias Corporation contained the following information.
Accounts receivable | $ 5,000 |
Sales revenue | 75,000 |
Cash | 15,000 |
Salaries and wages expense | 20,000 |
Rent expense | 10,000 |
What was Macias Corporation’s net income?
d. Net income = Sales revenue ($75,000) − Salaries and wages expense ($20,000) − Rent expense ($10,000) = $45,000. The other choices are therefore incorrect.
9. (LO 3) What section of a statement of cash flows indicates the cash spent on new equipment during the past accounting period?
a. The investing activities section of the statement of cash flows provides information about property, plant, and equipment accounts, not (b) the operating activities section or (c) the financing activities section. Choice (d) is incorrect as the statement of cash flows does provide this information.
10. (LO 3) Which statement presents information as of a specific point in time?
b. The balance sheet presents information as of a specific point in time. The other choices are incorrect because the (a) income statement, (c) statement of cash flows, and (d) retained earnings statement all cover a period of time.
11. (LO 3) Which financial statement reports assets, liabilities, and stockholders’ equity?
c. The balance sheet is a formal presentation of the accounting equation, such that Assets = Liabilities + Stockholders’ Equity, not the (a) income statement, (b) retained earnings statement, or (d) statement of cash flows.
12. (LO 3) Stockholders’ equity represents:
d. Stockholders’ equity represents claims of owners. The other choices are incorrect because (a) claims of creditors and (b) claims of employees are liabilities. Choice (c) is incorrect because the difference between revenues and expenses is net income.
13. (LO 3) As of December 31, 2025, Rockford Corporation has assets of $3,500 and stockholders’ equity of $1,500. What are the liabilities for Rockford as of December 31, 2025?
d. Using the accounting equation, liabilities can be computed by subtracting stockholders’ equity from assets, or $3,500 − $1,500 = $2,000, not (a) $1,500, (b) $1,000, or (c) $2,500.
14. (LO 3) The element of a corporation’s annual report that describes the corporation’s accounting methods is/are the:
a. The corporation’s accounting methods are described in the notes to the financial statements, not in the (b) management discussion and analysis, (c) auditor’s report, or (d) income statement.
15. (LO 3) The element of the annual report that presents an opinion regarding the fairness of the presentation of the financial position and results of operations is/are the:
b. The element of the annual report that presents an opinion regarding the fairness of the presentation of the financial position and results of operations is the auditor’s opinion, not the (a) income statement, (c) balance sheet, or (d) comparative statements.
Use basic accounting equation.
1. (LO 3) At the beginning of the year, Ortiz Company had total assets of $900,000 and total liabilities of $440,000. Answer the following questions.
a. | Assets | – | Liabilities | = | Stockholders’ Equity |
($900,000 – $100,000) | – | ($440,000 + $80,000) | = | $280,000 | |
b. | Liabilities | + | Stockholders’ Equity | = | Assets |
($440,000 – $100,000) | + | ($900,000 – $440,000 + $200,000) | = | $1,000,000 | |
c. | Assets | – | Stockholders’ Equity | = | Liabilities |
($900,000 + $50,000) | – | ($900,000 – $440,000 + $60,000) | = | $430,000 |
Determine where items appear on financial statements.
2. (LO 3) Indicate whether the following items would appear on the income statement (IS), balance sheet (BS), or retained earnings statement (RES).
Prepare a balance sheet.
3. (LO 3) Presented below in alphabetical order are balance sheet items for Feagler Company at December 31, 2025. Prepare a balance sheet following the format of Illustration 1.8.
Accounts receivable | $12,500 |
Cash | 38,000 |
Common stock | 5,000 |
Notes payable | 40,000 |
Retained earnings | 5,500 |
Feagler Company Balance Sheet December 31, 2025 |
||
Assets | ||
Cash | $38,000 | |
Accounts receivable | 12,500 | |
Total assets | $50,500 | |
Liabilities and Stockholders’ Equity | ||
Liabilities | ||
Notes payable | $40,000 | |
Total liabilities | $40,000 | |
Stockholders’ equity | ||
Common stock | 5,000 | |
Retained earnings | 5,500 | |
Total stockholders’ equity | 10,500 | |
Total liabilities and stockholders’ equity | $50,500 |
Determine where items appear on financial statements.
4. (LO 3) Identify whether the following items would appear on the balance sheet (BS) or income statement (IS) of a corporation.
Prepare an income statement.
1. (LO 3) The following items and amounts were taken from Ricardo Inc.’s 2025 income statement and balance sheet.
Cash | $ 84,700 | Inventory | $ 64,618 |
Retained earnings | 123,192 | Accounts receivable | 88,419 |
Cost of goods sold | 483,854 | Sales revenue | 693,485 |
Salaries and wages expense | 125,000 | Income taxes payable | 6,499 |
Prepaid insurance | 7,818 | Accounts payable | 49,384 |
Interest expense | 994 | Service revenue | 8,998 |
Instructions
Prepare an income statement for Ricardo Inc. for the year ended December 31, 2025.
Ricardo Inc. Income Statement For the Year Ended December 31, 2025 |
||||
Revenues | ||||
Sales revenue | $693,485 | |||
Service revenue | 8,998 | |||
Total revenues | $702,483 | |||
Expenses | ||||
Cost of goods sold | 483,854 | |||
Salaries and wages expense | 125,000 | |||
Interest expense | 994 | |||
Total expenses | 609,848 | |||
Net income | $ 92,635 | |||
Compute net income and prepare a balance sheet.
2. (LO 3) Cozy Bear is a private camping ground near the Mountain Home Recreation Area. It has compiled the following financial information as of December 31, 2025.
Service revenue (from camping fees) | $148,000 | Dividends | $9,000 |
Sales revenue (from general store) | 35,000 | Bonds payable | 50,000 |
Accounts payable | 16,000 | Expenses during 2025 | 135,000 |
Cash | 18,500 | Supplies | 12,500 |
Equipment | 129,000 | Common stock | 40,000 |
Retained earnings (1/1/2025) | 15,000 |
Instructions
Service revenue | $148,000 |
Sales revenues | 35,000 |
Total revenue | 183,000 |
Expenses | 135,000 |
Net income | $ 48,000 |
Cozy Bear Retained Earnings Statement For the Year Ended December 31, 2025 |
|||
Retained earnings, January 1 | $15,000 | ||
Add: Net income | 48,000 | ||
63,000 | |||
Less: Dividends | 9,000 | ||
Retained earnings, December 31 | $54,000 | ||
Cozy Bear Balance Sheet December 31, 2025 |
||||
Assets | ||||
Cash | $ 18,500 | |||
Supplies | 12,500 | |||
Equipment | 129,000 | |||
Total assets | $160,000 | |||
Liabilities and Stockholders’ Equity | ||||
Liabilities | ||||
Accounts payable | $16,000 | |||
Bonds payable | 50,000 | |||
Total liabilities | $ 66,000 | |||
Stockholders’ equity | ||||
Common stock | 40,000 | |||
Retained earnings | 54,000 | |||
Total stockholders’ equity | 94,000 | |||
Total liabilities and stockholders’ equity | $160,000 | |||
Prepare financial statements.
(LO 3) Jeff Andringa, a former college hockey player, quit his job and started Ice Camp, a hockey camp for kids ages 8 to 18. Eventually, he would like to open hockey camps nationwide. Jeff has asked you to help him prepare financial statements at the end of 2025, his first year of operations. He relates the following facts about his business activities.
In order to get the business off the ground, Jeff decided to incorporate. He sold shares of common stock to a few close friends, as well as bought some of the shares himself. He initially raised $25,000 through the sale of these shares. In addition, the company took out a $10,000 loan at a local bank.
Ice Camp purchased, for $12,000 cash, a bus for transporting kids. The company also bought hockey goals and other miscellaneous equipment with $1,500 cash. The company earned camp tuition of $100,000 during the year but had collected only $80,000 of this amount. Thus, at the end of the year, its customers still owed $20,000. The company rents time at a local rink for $50 per hour. Total rink rental costs during the year were $8,000, insurance was $10,000, salary expense was $20,000, and supplies used totaled $9,000, all of which were paid in cash. The company incurred $800 in interest expense on the bank loan, which it still owed at the end of the year.
The company paid dividends during the year of $5,000 cash. The balance in the corporate bank account at December 31, 2025, was $49,500.
Instructions
Using the format of the Sierra Corporation statements in this chapter, prepare an income statement, retained earnings statement, balance sheet, and statement of cash flows. (Hint: Prepare the statements in the order stated to take advantage of the flow of information from one statement to the next, as shown in Illustration 1.10.)
Ice Camp Income Statement For the Year Ended December 31, 2025 |
||||
Revenues | ||||
Service revenue | $100,000 | |||
Expenses | ||||
Salaries and wages expense | $20,000 | |||
Insurance expense | 10,000 | |||
Supplies expense | 9,000 | |||
Rent expense | 8,000 | |||
Interest expense | 800 | |||
Total expenses | 47,800 | |||
Net income | $ 52,200 | |||
Ice Camp Retained Earnings Statement For the Year Ended December 31, 2025 |
||||
Retained earnings, January 1, 2025 | $0 | |||
Add: Net income | 52,200 | |||
52,200 | ||||
Less: Dividends | 5,000 | |||
Retained earnings, December 31, 2025 | $47,200 | |||
Ice Camp Balance Sheet December 31, 2025 |
||||
Assets | ||||
Cash | $49,500 | |||
Accounts receivable | 20,000 | |||
Equipment ($12,000 + $1,500) | 13,500 | |||
Total assets | $83,000 | |||
Liabilities and Stockholders’ Equity | ||||
Liabilities | ||||
Notes payable | $10,000 | |||
Interest payable | 800 | |||
Total liabilities | $10,800 | |||
Stockholders’ equity | ||||
Common stock | 25,000 | |||
Retained earnings | 47,200 | |||
Total stockholders’ equity | 72,200 | |||
Total liabilities and stockholders’ equity | $83,000 | |||
Ice Camp Statement of Cash Flows For the Year Ended December 31, 2025 |
||||
Cash flows from operating activities | ||||
Cash receipts from operating activities | $80,000 | |||
Cash payments for operating activities | (47,000) | |||
Net cash provided by operating activities | $33,000 | |||
Cash flows from investing activities | ||||
Purchase of equipment | (13,500) | |||
Net cash used by investing activities | (13,500) | |||
Cash flows from financing activities | ||||
Issuance of common stock | 25,000 | |||
Issuance of notes payable | 10,000 | |||
Dividends paid | (5,000) | |||
Net cash provided by financing activities | 30,000 | |||
Net increase in cash | 49,500 | |||
Cash at beginning of period | 0 | |||
Cash at end of period | $49,500 | |||
1. What are the three basic forms of business organizations?
2. What are the advantages to a business of being formed as a corporation? What are the disadvantages?
3. What are the advantages to a business of being formed as a partnership or sole proprietorship? What are the disadvantages?
4. Is it possible to create a company using an organizational form that has the advantages of both a partnership and a corporation? Explain.
5. “Accounting is ingrained in our society and is vital to our economic system.” Do you agree? Explain.
6. Who are the internal users of accounting data? How does accounting provide relevant data to the internal users?
7. Who are the external users of accounting data? Give examples.
8. What are the four most common types of data analytics, and what basic question does each address?
9. What are the three main types of business activity? Give examples of each activity.
10. Listed here are some items found in the financial statements of Finzelberg. Indicate in which financial statement(s) each item would appear.
11. Why would a bank want to monitor the dividend payment practices of the corporations to which it lends money?
12. “A company’s net income appears directly on the income statement and the retained earnings statement, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain.
13. What is the primary purpose of the statement of cash flows?
14. What are the three main categories of the statement of cash flows? Why do you think these categories were chosen?
15. What is retained earnings? What items increase the balance in retained earnings? What items decrease the balance in retained earnings?
16. What is the basic accounting equation?
17.
18. Which of these items are liabilities of White Glove Cleaning Service?
19. How are each of the following financial statements interrelated? (a) Retained earnings statement and income statement. (b) Retained earnings statement and balance sheet. (c) Balance sheet and statement of cash flows.
20. What is the purpose of the management discussion and analysis section (MD&A)?
21. Why is it important for financial statements to receive an unqualified auditor’s opinion?
22. What types of information are presented in the notes to the financial statements?
23. The accounting equation is Assets = Liabilities + Stockholders’ Equity. Appendix A reproduces Apple’s financial statements. Replacing words in the equation with dollar amounts, what is Apple’s accounting equation at September 26, 2020?
24. What are the characteristics of a “critical audit matter”?
Describe forms of business organization.
BE1.1 (LO 1), K Match each of the following forms of business organization with a set of characteristics: sole proprietorship (SP), partnership (P), and corporation (C).
Identify users of accounting information.
BE1.2 (LO 1), K The following lists situations that require the use of accounting information.
Match each of the situations with the following users of accounting information.
Classify items by activity.
BE1.3 (LO 2), K Indicate to which business activity, operating activity (O), investing activity (I), or financing activity (F), each item relates.
Determine effect of transactions on stockholders’ equity.
BE1.4 (LO 3), C Presented below are a number of transactions. Determine whether each transaction affects common stock (C), dividends (D), revenues (R), expenses (E), or does not affect stockholders’ equity (NSE). Provide titles for the revenues and expenses.
Prepare a balance sheet.
BE1.5 (LO 3), AP In alphabetical order below are balance sheet items for Karol Company at December 31, 2025. Prepare a balance sheet following the format of Illustration 1.8.
Accounts payable | $65,000 |
Accounts receivable | 71,000 |
Cash | 22,000 |
Common stock | 18,000 |
Retained earnings | 10,000 |
Determine where items appear on financial statements.
BE1.6 (LO 3), K Eskimo Pie Corporation markets a broad range of frozen treats, including its famous Eskimo Pie ice cream bars. The following items were taken from a recent income statement and balance sheet. In each case, identify whether the item would appear on the balance sheet (BS) or income statement (IS).
Determine proper financial statement.
BE1.7 (LO 3), K Indicate which statement you would examine to find each of the following items: income statement (IS), balance sheet (BS), retained earnings statement (RES), or statement of cash flows (SCF).
Use basic accounting equation.
BE1.8 (LO 3), AP Use the basic accounting equation to answer these questions.
Use basic accounting equation.
BE1.9 (LO 3), AP At the beginning of the year, Morales Company had total assets of $800,000 and total liabilities of $500,000. (Treat each item independently.)
Identify assets, liabilities, and stockholders’ equity.
BE1.10 (LO 3), K Indicate whether each of these items is an asset (A), a liability (L), or part of stockholders’ equity (SE).
Determine required parts of annual report.
BE1.11 (LO 3), K Which is not a required part of an annual report of a publicly traded company?
Identify benefits of business organization forms.
DO IT! 1.1a (LO 1), C Identify each of the following organizational characteristics with the business organizational form or forms with which it is associated.
Identify accounting terms.
DO IT 1.1b (LO 1), C Match each of the following terms with its definition, classification type, or associated phrase.
Classify financial statement elements.
DO IT! 1.2 (LO 2), K Classify each item as an asset, liability, common stock, revenue, or expense.
Prepare financial statements.
DO IT! 1.3a (LO 3), AP Gray Corporation began operations on January 1, 2025. The following information is available for Gray on December 31, 2025.
Accounts payable | $ 5,000 | Notes payable | $ 7,000 |
Accounts receivable | 2,000 | Rent expense | 10,000 |
Advertising expense | 4,000 | Retained earnings | ? |
Cash | 3,100 | Service revenue | 25,000 |
Common stock | 15,000 | Supplies | 1,900 |
Dividends | 2,500 | Supplies expense | 1,700 |
Equipment | 26,800 |
Prepare an income statement, a retained earnings statement, and a balance sheet for Gray Corporation.
Identify components of annual reports.
DO IT! 1.3b (LO 3), K Indicate whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the financial statements, or the auditor’s report.
Match items with descriptions.
E1.1 (LO 1, 2, 3), K Here is a list of words or phrases discussed in this chapter:
Instructions
Match each word or phrase above with the best description of it.
Identify forms of business organization.
E1.2 (LO 1), C Consider the following statements.
Sole Proprietorship | Partnership | Corporation | |
|
Instructions
Complete the above by indicating if each of the statements is normally true (T) or false (F) for each type of business organization: sole proprietorship, partnership, and corporation.
Identify users of accounting information.
E1.3 (LO 1), C The following list presents different types of evaluations made by various users of accounting information.
Instructions
Complete the following by indicating (a) the number of the evaluation (1 to 6) that the user would most likely make, and (b) if the user is internal or external.
(a) Type of Evaluation | (b) Type of User | |
Investor | ||
Marketing manager | ||
Creditor | ||
Chief financial officer | ||
Internal Revenue Service | ||
Labor union |
Match items with descriptions.
E1.4 (LO 1, 2, 3), K The following terms or phrases are discussed in this chapter.
Instructions
Match each term or phrase to its description below.
Identify business activities.
E1.5 (LO 2), C All businesses are involved in three types of activities—financing, investing, and operating. Listed below are the names and descriptions of companies in several different industries.
Instructions
Classify business activities.
E1.6 (LO 2), K Consider the following business activities that occur at a Colorado ski area.
Instructions
Classify each of the above items by type of business activity: operating (O), investing (I), or financing (F).
Classify accounts.
E1.7 (LO 2, 3), C The Bonita Vista Golf & Country Club details the following accounts in its financial statements.
Accounts payable | _____ |
Accounts receivable | _____ |
Equipment | _____ |
Sales revenue | _____ |
Service revenue | _____ |
Inventory | _____ |
Mortgage payable | _____ |
Supplies expense | _____ |
Rent expense | _____ |
Salaries and wages expense | _____ |
Instructions
Classify each of the accounts as an asset (A), liability (L), stockholders’ equity (SE), revenue (R), or expense (E) item.
Identify financial statements.
E1.8 (LO 3), K Consider the following typical accounts and statement items.
Instructions
Indicate on which statement—income statement (IS), balance sheet (BS), retained earning statement (RE), and/or statement of cash flows (SCF)—you would find each of the above accounts or items.
Prepare income statement and retained earnings statement.
E1.9 (LO 3), AP This information relates to Benser Co. for the year 2025.
Retained earnings, January 1, 2025 | $67,000 |
Advertising expense | 1,800 |
Dividends | 6,000 |
Rent expense | 10,400 |
Service revenue | 58,000 |
Utilities expense | 2,400 |
Salaries and wages expense | 30,000 |
Instructions
Prepare an income statement and a retained earnings statement for the year ending December 31, 2025.
Prepare income statement and retained earnings statement.
E1.10 (LO 3), AP Suppose the following information was taken from the 2025 financial statements of pharmaceutical giant Merck & Co. (All dollar amounts are in millions.)
Retained earnings, January 1, 2025 | $43,698.8 |
Cost of goods sold | 9,018.9 |
Selling and administrative expenses | 8,543.2 |
Dividends | 3,597.7 |
Sales revenue | 38,576.0 |
Research and development expense | 5,845.0 |
Income tax expense | 2,267.6 |
Instructions
Prepare a retained earnings statement.
E1.11 (LO 3), AP Presented here is information for Zheng Inc. for 2025.
Retained earnings, January 1 | $130,000 |
Service revenue | 400,000 |
Total expenses | 175,000 |
Dividends | 65,000 |
Instructions
Prepare the 2025 retained earnings statement for Zheng Inc.
Prepare a balance sheet.
E1.12 (LO 3), AP The following information is available for Randall Inc.
Accounts receivable | $2,400 | Cash | $6,250 |
Accounts payable | 3,700 | Supplies | 3,760 |
Interest payable | 580 | Unearned service revenue | 850 |
Salaries and wages expense | 4,500 | Salaries and wages payable | 745 |
Notes payable | 31,500 | Depreciation expense | 670 |
Common stock | 50,700 | Equipment (net) | 108,200 |
Inventory | 2,840 |
Instructions
Using the information above, prepare a balance sheet as of December 31, 2025. (Hint: Solve for the missing retained earnings amount after first determining total assets and total liabilities.)
Interpret financial data.
E1.13 (LO 3), AN Consider each of the following independent situations.
Instructions
For each company, provide a brief discussion interpreting these financial data. For example, you might discuss the company’s financial health or its apparent growth philosophy.
Identify financial statement components and prepare income statement.
E1.14 (LO 3), AP The following items and amounts were taken from Lonyear Inc.’s 2025 income statement and balance sheet.
______ Cash | $ 84,700 | ______ Accounts receivable | $ 88,419 |
______ Retained earnings | 123,192 | ______ Sales revenue | 584,951 |
______ Cost of goods sold | 438,458 | ______ Notes payable | 6,499 |
______ Salaries and wages expense | 115,131 | ______ Accounts payable | 49,384 |
______ Prepaid insurance | 7,818 | ______ Service revenue | 4,806 |
______ Inventory | 64,618 | ______ Interest expense | 1,882 |
Instructions
Identify financial statement components and prepare income statement.
E1.15 (LO 3), AP The following items and amounts were taken from Familia Inc.’s 2025 income statement and balance sheet, the end of its first year of operations.
______ Interest expense | $ 2,200 | ______ Equipment, net | $54,700 |
______ Interest payable | 700 | ______ Depreciation expense | 3,200 |
______ Notes payable | 11,800 | ______ Supplies | 4,100 |
______ Sales revenue | 44,300 | ______ Common stock | 26,800 |
______ Cash | 2,900 | ______ Supplies expense | 900 |
______ Salaries and wages expense | 15,600 |
Instructions
Calculate missing amounts.
E1.16 (LO 3), AN Here are incomplete financial statements for Donavan, Inc.
Donavan, Inc. Balance Sheet |
||||
Assets | Liabilities and Stockholders’ Equity | |||
Cash | $ 7,000 | Liabilities | ||
Inventory | 10,000 | Accounts payable | $ 5,000 | |
Buildings (net) | 45,000 | Stockholders’ equity | ||
Total assets | $62,000 | Common stock | (a) | |
Retained earnings | (b) | |||
Total liabilities and stockholders’ equity | $62,000 |
Income Statement | |
Revenues | $85,000 |
Cost of goods sold | (c) |
Salaries and wages expense | 10,000 |
Net income | $(d) |
Retained Earnings Statement | |
Beginning retained earnings | $12,000 |
Add: Net income | (e) |
Less: Dividends | 5,000 |
Ending retained earnings | $27,000 |
Instructions
Calculate the missing amounts.
Calculate missing amounts.
E1.17 (LO 3), AN Here are incomplete financial statements for Oway Corporation.
Oway Corporation Balance Sheet |
|||
Assets | Liabilities and Stockholders’ Equity | ||
Cash | $ 29,000 | Liabilities | |
Supplies | (a) | Notes payable | $22,000 |
Equipment (net) | 65,000 | Stockholders’ equity | |
Total assets | $(b) | Common stock | 38,000 |
Retained earnings | (c) | ||
Total liabilities and stockholders’ equity | $(d) |
Income Statement | |
Revenues | $53,000 |
Depreciation expense | (e) |
Salaries and wages expense | 10,000 |
Interest expense | 1,000 |
Net income | $25,000 |
Retained Earnings Statement | |
Beginning retained earnings | $(f) |
Add: Net income | (g) |
Less: Dividends | 6,000 |
Ending retained earnings | $37,000 |
Instructions
Calculate the missing amounts.
Compute net income and prepare a retained earnings statement and balance sheet.
E1.18 (LO 3), AP Otay Lakes Park is a private camping ground near the Mount Miguel Recreation Area. It has compiled the following financial information as of December 31, 2025.
Service revenue (from camping fees) | $132,000 | Dividends | $ 9,000 |
Sales revenue (from general store) | 25,000 | Notes payable | 50,000 |
Accounts payable | 11,000 | Expenses during 2025 | 126,000 |
Cash | 8,500 | Supplies | 5,500 |
Equipment | 114,000 | Common stock | 40,000 |
Retained earnings (1/1/2025) | 5,000 |
Instructions
Identify financial statement components and prepare an income statement.
E1.19 (LO 3), AP Kellogg Company is the world’s leading producer of ready-to-eat cereal and a leading producer of grain-based convenience foods such as frozen waffles and cereal bars. Suppose the following items were taken from its 2025 income statement and balance sheet. (All dollars are in millions.)
____ Retained earnings | $5,481 | ____ Bonds payable | $ 4,835 |
____ Cost of goods sold | 7,184 | ____ Inventory | 910 |
____ Selling and administrative expenses | 3,390 | ____ Sales revenue | 12,575 |
____ Accounts payable | 1,077 | ||
____ Cash | 334 | ____ Common stock | 105 |
____ Notes payable | 44 | ____ Income tax expense | 498 |
____ Interest expense | 295 |
Instructions
Prepare a statement of cash flows.
E1.20 (LO 3), AP This information is for Williams Corporation for the year ended December 31, 2025.
Cash received from lenders | $20,000 |
Cash received from customers | 50,000 |
Cash paid for new equipment | 28,000 |
Cash dividends paid | 8,000 |
Cash paid to suppliers | 16,000 |
Cash balance 1/1/25 | 12,000 |
Instructions
Prepare a statement of cash flows.
E1.21 (LO 3), AP Suppose the following data are derived from the 2025 financial statements of Southwest Airlines. (All dollars are in millions.) Southwest has a December 31 year-end.
Cash balance, January 1, 2025 | $1,390 |
Cash paid for repayment of debt | 122 |
Cash received from issuance of common stock | 144 |
Cash received from issuance of long-term debt | 500 |
Cash received from customers | 9,823 |
Cash paid for property and equipment | 1,529 |
Cash paid for dividends | 14 |
Cash paid for repurchase of common stock | 1,001 |
Cash paid for goods and services | 6,978 |
Instructions
Correct an incorrectly prepared balance sheet.
E1.22 (LO 3), AP Wayne Holtz is the bookkeeper for Beeson Company. Wayne has been trying to get the balance sheet of Beeson Company to balance. It finally balanced, but now he’s not sure it is correct.
Beeson Company Balance Sheet December 31,.2025 |
||||
Assets | Liabilities and Stockholders’ Equity | |||
Cash | $18,000 | Accounts payable | $16,000 | |
Supplies | 9,500 | Accounts receivable | (12,000) | |
Equipment | 40,000 | Common stock | 40,000 | |
Dividends | 8,000 | Retained earnings | 31,500 | |
Total assets | $75,000 | Total liabilities and stockholders’ equity | $75,000 |
Instructions
Prepare a correct balance sheet.
Classify items as assets, liabilities, and stockholders’ equity, and prepare accounting equation.
E1.23 (LO 3), AP Suppose the following items were taken from the balance sheet of Nike, Inc. (All dollars are in millions.)
1.____ Cash | $2,291.1 |
2.____ Accounts receivable | 2,883.9 |
3.____ Common stock | 2,874.2 |
4.____ Notes payable | 342.9 |
5.____ Buildings | 3,759.9 |
6.____ Mortgage payable | 1,311.5 |
7.____ Inventory | $2,357.0 |
8.____ Income taxes payable | 86.3 |
9.____ Equipment | 1,957.7 |
10.____ Retained earnings | 5,818.9 |
11.____ Accounts payable | 2,815.8 |
Instructions
Perform each of the following.
Use financial statement relationships to determine missing amounts.
E1.24 (LO 3), AN The summaries of data from the balance sheet, income statement, and retained earnings statement for two corporations, Walco Corporation and Gunther Enterprises, are presented as follows for 2025.
Walco Corporation | Gunther Enterprises | |
Beginning of year | ||
Total assets | $110,000 | $150,000 |
Total liabilities | 70,000 | (d) |
Total stockholders’ equity | (a) | 70,000 |
End of year | ||
Total assets | (b) | 180,000 |
Total liabilities | 120,000 | 55,000 |
Total stockholders’ equity | 60,000 | (e) |
Changes during year in retained earnings | ||
Dividends | (c) | 5,000 |
Total revenues | 215,000 | (f) |
Total expenses | 165,000 | 80,000 |
Instructions
Determine the missing amounts. Assume all changes in stockholders’ equity are due to changes in retained earnings.
Classify various items in an annual report.
E1.25 (LO 3), K The annual report provides financial information in a variety of formats, including the following.
Management discussion and analysis (MD&A)
Financial statements
Notes to the financial statements
Auditor’s opinion
Instructions
For each of the following, state in what area of the annual report the item would be presented. If the item would probably not be found in an annual report, state “Not disclosed.”
Classify accounts and prepare balance sheet.
E1.26 (LO 3), AP The following list of accounts, in alphabetical order, is for Aventura Inc. at November 30, 2025.
____ Accounts payable | $ 26,200 | ____ Inventory | $18,000 |
____ Accounts receivable | 19,500 | ____ Land | 44,000 |
____ Buildings | 100,000 | ____ Mortgage payable | 97,500 |
____ Cash | 20,000 | ____ Notes payable | 34,000 |
____ Common stock | 20,000 | ____ Retained earnings | 48,500 |
____ Equipment, net | 30,000 | ____ Supplies | 700 |
____ Income taxes payable | 6,000 |
Instructions
Determine forms of business organization.
P1.1 (LO 1), C Presented below are five independent situations.
Instructions
In each case, explain what form of organization the business is likely to take—sole proprietorship, partnership, or corporation. Give reasons for your choice.
Identify users and uses of financial statements.
P1.2 (LO 3), C Financial decisions often place heavier emphasis on one type of financial statement over the others. Consider each of the following hypothetical situations independently.
Instructions
In each situation, state whether the decision-maker would be most likely to place primary emphasis on information provided by the income statement, balance sheet, or statement of cash flows. In each case provide a brief justification for your choice. Choose only one financial statement in each case.
Prepare an income statement, retained earnings statement, and balance sheet; discuss results.
P1.3 (LO 3), AP On June 1, 2025, Elite Service Co. was started with an initial investment in the company of $22,100 cash. Here are the assets, liabilities, and common stock of the company at June 30, 2025, and the revenues and expenses for the month of June, its first month of operations:
Cash | $ 4,600 | Notes payable | $12,000 |
Accounts receivable | 4,000 | Accounts payable | 500 |
Service revenue | 7,500 | Supplies expense | 1,000 |
Supplies | 2,400 | Maintenance and repairs expense | 600 |
Advertising expense | 400 | Utilities expense | 300 |
Equipment | 26,000 | Salaries and wages expense | 1,400 |
Common stock | 22,100 |
During June, the company issued no additional stock but paid dividends of $1,400.
Check figures provide a key number to let you know you are on the right track.
Instructions
Net income | $3,800 | |
Ret. earnings | $2,400 | |
Tot. assets | $37,000 |
Prepare an income statement, retained earnings statement, and balance sheet.
P1.4 (LO 3), AP Reese Inc., a provider of consulting services, was founded on October 1, 2025. At the end of the first month of operations, the company decided to prepare an income statement, retained earnings statement, and balance sheet using the following information.
Accounts payable | $ 3,300 | Supplies | $ 2,460 |
Interest expense | 410 | Supplies expense | 380 |
Equipment (net) | 48,200 | Depreciation expense | 270 |
Salaries and wages expense | 2,500 | Service revenue | 20,920 |
Bonds payable | 21,500 | Salaries and wages payable | 445 |
Unearned service revenue | 4,065 | Common stock | 9,100 |
Accounts receivable | 1,300 | Interest payable | 140 |
Cash | 3,950 |
Instructions
Using the information, prepare an income statement and retained earnings statement for the month of October 2025 and a balance sheet as of October 31, 2025.
End. retained earnings | $17,360 |
Determine items included in a statement of cash flows, prepare the statement, and comment.
P1.5 (LO 3), AP Presented below is selected financial information for Rojo Corporation for December 31, 2025.
Inventory | $ 25,000 | Cash paid to purchase equipment | $ 12,000 |
Cash paid to suppliers | 104,000 | Equipment | 40,000 |
Buildings | 200,000 | Service revenue | 100,000 |
Common stock | 50,000 | Cash received from customers | 132,000 |
Cash dividends paid | 7,000 | Cash received from issuing common stock | 22,000 |
Cash at beginning of period | 9,000 |
Instructions
Net cash increase | $31,000 |
Comment on proper accounting treatment and prepare a corrected balance sheet.
P1.6 (LO 3), AN Micado Corporation was formed on January 1, 2025. At December 31, 2025, Miko Liu, the president and sole stockholder, decided to prepare a balance sheet, which appeared as follows.
Micado Corporation Balance Sheet December 31, 2025 |
||||
Assets | Liabilities and Stockholders’ Equity | |||
Cash | $20,000 | Accounts payable | $30,000 | |
Accounts receivable | 50,000 | Notes payable | 15,000 | |
Inventory | 36,000 | Boat loan | 22,000 | |
Boat | 24,000 | Stockholders’ equity | 63,000 |
Miko willingly admits that she is not an accountant by training. She is concerned that her balance sheet might not be correct. She has provided you with the following additional information.
Instructions
Tot. assets | $85,000 |
The Cookie Creations case starts in Chapter 1 and continues in every chapter. Complete case details and instructions are available in Wiley Course Resources.
CCC1 Natalie Koebel spent much of her childhood learning the art of cookie-making from her grand mother. They spent many happy hours mastering every type of cookie imaginable and later devised new recipes that were both healthy and delicious. Now at the start of her second year in college, Natalie is investigating possibilities for starting her own business as part of the entrepreneurship program in which she is enrolled.
A long-time friend insists that Natalie has to include cookies in her business plan. After a series of brainstorming sessions, Natalie settles on the idea of operating a cookie-making school. She will start on a part-time basis and offer her services in people’s homes. Now that she has started thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday cookies. She will offer group sessions (which will probably be more entertainment than education) and individual lessons. Natalie also decides to include children in her target market. The first difficult decision is coming up with the perfect name for her business. She settles on “Cookie Creations,” and then moves on to more important issues.
Instructions
CT1.1 The financial statements of Apple Inc. are presented in Appendix A.
Instructions
Refer to Apple’s financial statements and answer the following questions.
CT1.2 Columbia Sportswear Company’s financial statements are presented in Appendix B. Financial statements of Under Armour, Inc. are presented in Appendix C.
Instructions
CT1.3 Amazon.com, Inc.’s financial statements are presented in Appendix D. Financial statements of Walmart Inc. are presented in Appendix E.
Instructions
CT1.4 Xerox was not having a particularly pleasant year. The company’s stock price had already fallen in the previous year from $60 per share to $30. Just when it seemed things couldn’t get worse, Xerox’s stock fell to $4 per share. The following data were taken from the statement of cash flows of Xerox. (All dollars are in millions.)
Cash used in operating activities | $ (663) | |
Cash used in investing activities | (644) | |
Financing activities | ||
Dividends paid | $ (587) | |
Net cash received from issuing debt | 3,498 | |
Cash provided by financing activities | 2,911 |
Instructions
Analyze the information and then answer the following questions.
CT1.5 You can easily search the Internet to find summary information about companies. This information includes basic descriptions of the company’s location, activities, industry, financial health, and financial performance.
Instructions
Go to the Yahoo! Finance website, type in a company name, and then use the links (such as Financials) to locate the information necessary to answer the following questions.
CT1.6 The Wall Street Journal published an article by Michael Rapoport entitled “Coming Soon: What Auditors Really Think About Company Numbers.” It provides a discussion about changes to be made to the auditor’s report.
Instructions
Read the article and then answer the following questions.
CT1.7 Sylvia Ayala recently accepted a job in the production department at Johnson & Johnson. Before she starts work, she decides to review the company’s annual report to better understand its operations.
The content and organization of corporate annual reports have become fairly standardized. Excluding the public relations part of the report (pictures, products, etc.), the following are the traditional financial portions of the annual report.
The official SEC filing of the annual report is called a Form 10-K, which often omits the public relations pieces found in most standard annual reports.
Instructions
Search the Internet to find Johnson & Johnson’s 10-K report dated for the year ended January 3, 2021, to answer the following questions.
CT1.8 Marci Ling is the bookkeeper for Samco Company, Inc. Marci has been trying to get the company’s balance sheet to balance. She finally got it to balance, but she still isn’t sure that it is correct.
Samco Company, Inc. Balance Sheet For the Month Ended December 31, 2025 |
||||
Assets | Liabilities and Stockholders’ Equity | |||
Equipment | $18,000 | Common stock | $12,000 | |
Cash | 9,000 | Accounts receivable | (6,000) | |
Supplies | 1,000 | Dividends | (2,000) | |
Accounts payable | (4,000) | Notes payable | 10,000 | |
Total assets | $24,000 | Retained earnings | 10,000 | |
Total liabilities and stockholders’ equity | $24,000 |
Instructions
Explain to Marci Ling in a memo (a) the purpose of a balance sheet, and (b) why this balance sheet is incorrect and what she should do to correct it.
CT1.9 Rules governing the investment practices of individual certified public accountants prohibit them from investing in the stock of a company that their firm audits. The Securities and Exchange Commission (SEC) became concerned that some accountants were violating this rule. In response to an SEC investigation, PricewaterhouseCoopers (PwC) fired 10 people and spent $25 million educating employees about the investment rules and installing an investment tracking system.
Instructions
Answer the following questions.
CT1.10 Ethical behavior is fundamental to communications between investors and companies. However, it is difficult for company founders to control their enthusiasm in discussions related to their company, such that sometimes new companies overstate their potential for future success, either intentionally or unintentionally, in order to generate investor interest.
For example, Nikola Corporation, a pioneer in electric semi-trucks, was investigated by U.S. securities regulators because critics claimed that the company’s chairperson made false claims about the company’s progress in his efforts to make Nikola “the Tesla of semi-trucks.” Shortly after its stock began trading publicly, the company was estimated to be worth $30 billion, even though it had yet to produce its first electric truck. Similarly, Tesla’s founder and CEO, Elon Musk, has been investigated by the Securities and Exchange Commission a number of times regarding the accuracy of his communications, including Tweets.
Instructions
In groups, discuss the following topics.
CT1.11 Some people are tempted to make their finances look worse to get financial aid. Companies sometimes also manage their financial numbers in order to accomplish certain goals. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. In managing earnings, companies’ actions vary from being within the range of ethical activity, to being both unethical and illegal attempts to mislead investors and creditors.
Instructions
Provide responses for each of the following questions.
CT1.12 The FASB has developed the Financial Accounting Standards Board Accounting Standards Codification (or more simply “the Codification”). The FASB’s primary goal in developing the Codification is to provide in one place all the authoritative literature related to a particular topic. To provide easy access to the Codification, the FASB also developed the Financial Accounting Standards Board Codification Research System (CRS). CRS is an online, real-time database that provides easy access to the Codification. The Codification and the related CRS provide a topically organized structure, subdivided into topic, subtopics, sections, and paragraphs, using a numerical index system.
You may find this system useful in your present and future studies, and so we have provided an opportunity to use this online system as part of the Expand Your Critical Thinking section.
Instructions
Academic access to the FASB Codification is available through university subscriptions, obtained from the American Accounting Association. This subscription covers an unlimited number of students within a single institution. Once this access has been obtained by your school, you should log in and familiarize yourself with the resources that are accessible at the FASB Codification site.
CT1.13 Although Clif Bar & Company is not a public company, it does share its financial information with its employees as part of its open-book management approach. Further, although it does not publicly share its financial information, it does provide a different form of an annual report to external users. In this report, the company provides information regarding its sustainability efforts.
Instructions
Go to the “Who We Are” page at the Clif Bar website and then identify the company’s five aspirations.
Many people believe that there is a need for one set of international accounting standards. Here is why:
The following are the key similarities and differences between GAAP and IFRS as related to accounting fundamentals.
Similarities
Differences
1. Which of the following is not a reason why a single set of high-quality international accounting standards would be beneficial?
2. The Sarbanes-Oxley Act determines:
3. IFRS is considered to be more:
IFRS1.1 Who are the two key international players in the development of international accounting standards? Explain their role.
IFRS1.2 What is the benefit of a single set of high-quality accounting standards?
IFRS1.3 The complete annual report of Louis Vuitton, including the notes to its financial statements, is available at the company’s website.
Answer the following questions from the company’s 2020 annual report.
a. What accounting firm performed the audit of Louis Vuitton’s financial statements?
b. What is the address of the company’s corporate headquarters?
c. What is the company’s reporting currency?
Answers to IFRS Self-Test Questions
1. d2. c3. a