Chapter 1 - The Financial Statements
Directed Reading Worksheet Answer Key
Part I: Explain why accounting is critical to businesses (LO1)
1. What are financial statements?
Business documents companies use to report the results of their activities to people and groups
that can include managers, investors, creditors, and regulatory agencies
2. List the basic financial statements.
a. Income statement
b. Statement of retained earnings
c. Balance sheet
d. Statement of cash flows
3. What does the word net refer to in accounting?
An amount after a subtraction
4. What is net income (profit)?
The excess of revenues (net sales) over expenses
5. What were net sales for The Walt Disney Company, for its year ended October 1, 2016? For its
year ended October 3, 2015? On what statement do you find this information?
2016: $55,632 million
2015: $52,465 million
Income Statement
6. _____________________ is an information system that measures business activities, processes
data into financial statements and reports, and communicates results to decision makers.
Accounting
7. What is the accounting cycle?
The process by which a company’s financial statements are prepared
8. _____________________ is a mechanical part of accounting, just as arithmetic is a part of
mathematics; accounting as a field is much more than this mechanical part.
Bookkeeping
9. Who uses accounting information?
a. Individuals
b. Investors and creditors

c. Regulatory bodies
d. Nonprofit organizations
10. What two branches of accounting are based on whether the user is external or internal?
a. Financial accounting (external)
b. Managerial accounting (internal)
11. A _____________________ form of business organization consists of a single owner and the
owner is personally liable for all the business’s debts.
Proprietorship
12. Income from the ______________________ form of business organization “flows through” to
the owners; each owner can legally bind all partners into unlimited debt.
Partnership
13. When organized as a _____________________, the owners are not personally liable for the
business’s debts and the business’s income “flows through” to the owners to be taxed at the
owners’ own tax rates.
Limited-Liability Company
14. Although its advantages include the ability to raise large sums of capital and the no personal
liability for its owners, one potential disadvantage of the _______________________ form of
business organization is that its income is subject to double taxation.
Corporation
15. Who (or what) ultimately controls a corporation?
Stockholders or shareholders who own stock in the corporation
Part II: Explain and apply underlying accounting concepts, assumptions, and principles (LO2)
16. Two professional frameworks for the measurement and disclosure of financial information are:
a. Generally Accepted Accounting Principles (GAAP)
b. International Financial Reporting Standards (IFRS)
17. What regulatory bodies formulate the standards for each respective framework in Question 16
above?
Financial Accounting Standards Board (FASB); International Accounting Standards Board (IASB)
18. Fill in the conceptual foundation of accounting in the following diagram. Also draw arrows
where appropriate to show relationships.

19. In your own words, describe the difference between relevance and faithful representation.
Relevance means that the information could change the outcome or make a decision maker
chose a different path. If information would have no impact on the decision, then it is not
relevant. If the information could change the decision makers mind, it is relevant.
Faithful representation means that the information is accurate. Faithful representation makes
the information reliable for decision makers to use it.
20. List and describe the four enhancing qualitative characteristics for accounting information.
a. Comparability: capable of being compared with information from other companies in the
same period
b. Verifiability: capable of being checked for accuracy, completeness, and reliability
c. Timeliness: made available to users early enough to help them make decisions
d. Understandability: transparent and clear enough so that it would make sense to the
reasonably informed user of information
21. List and describe the four accounting assumptions/principles.
a. Entity Assumption: This is the idea that the entity (organization or person) stands apart as a
separate economic unit. It is to keep entities and their affairs separate from others.
b. Continuity (Going-Concern Assumption): This says that a business should stay in business
long enough to convert its inventories and receivables to cash, pay off liabilities regularly, and

continue operations in the future.
c. Historical Cost Principle: This states that assets should be recorded at the cost paid for them
in cash and noncash compensation on the date of purchase.
d. Stable-Monetary-Unit Assumption: This ignores inflation and change in purchasing power to
assume that the value of the dollar is stable over time. This helps with comparability from year
to year.
22. _________________ is the amount that the business could sell the asset for, or the amount that
the business could pay to settle the liability.
Fair value
23. Why did the International Accounting Standards Board (IASB) develop International Financial
Reporting Standards (IFRS)?
The purpose was to create a uniform set of principles across the developed world and make
comparability of financial results simple and inexpensive.
Part III: Apply the accounting equation to business organizations (LO3)
24. Assets are economic resources that are expected to produce a _____________________ in the
future. Liabilities are debts that are payable to _____________________. Owners’ equity
represents the _____________________ claims of a business.
Benefit; Outsiders/Creditors; Insider
25. What is the accounting equation?
Assets = Liabilities + Owners’ (Stockholders’) Equity
26. ________________ are liquid assets that can be readily converted to cash. Give 2 examples.
Cash equivalents
Certificate of deposit, U.S. treasury bill
27. Liabilities payable beyond __________________ from the date of the financial statements are
long-term. Liabilities payable within __________________ from the date of the financial
statements are short-term.
One year; One year
28. What are the two main subparts of stockholders’ equity and what is the difference between
them?
Paid-in capital: the amount the stockholders have invested in the corporation
Retained earnings: the amount earned by income-producing activities and kept for use in the
business

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Solution Manual for Financial Accounting , 12th Edition

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