Essay on Chapter 2 Study Guide

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1. Identify the sections of a classified balance sheet. In a classified balance sheet, companies classify assets as current assets; long-term investments; property, plant, and equipment; or intangibles. They classify liabilities as either current or long-term. A stockholders’ equity section shows common stock and retained earnings.
2. Identify and compute ratios for analyzing a company’s profitability. Profitability ratios, such as earnings per share (EPS), measure aspects of the operating success of a company for a given period of time.
3. Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. The retained earnings statement presents the factors that changed the retained earnings balance during the period. A statement of stockholders’ equity presents the factors that changed stockholders’ equity during the period, including those that changed retained earnings. Thus, a statement of stockholders’ equity is more inclusive. 4. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. Liquidity ratios, such as the current ratio, measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios, such as the debt to total assets ratio, measure the ability of an enterprise to survive over a long period. 5. Use the statement of cash flows to evaluate solvency. Free cash flow indicates a company’s ability to generate cash from operations that are sufficient to pay debts, acquire assets, and distribute dividends.
6. Explain the meaning of generally accepted accounting principles. Generally accepted accounting principles are a set of rules and practices recognized as a general guide for financial reporting purposes. The basic objectives of financial reporting is to provide information that is useful for decision making.
7. Discuss financial reporting concepts. To be judged useful, information should posses these qualitative characteristics relevance, reliability, comparability, and consistency.
The monetary unit assumption requires that companies include in the accounting records of the economic entity only transaction data capable of being expressed in terms of money. The economic entity assumption states that economic events can be identified with a particular unit of accountability. The time period assumption states that the economic life of a business can be divided into artificial time periods and that meaningful accounting reports can be prepared for each period. The going concern assumption states that the enterprise will continue in operation long enough to carry out its existing objectives and commitments.
The cost principle states that the companies should record assets at their cost. The full disclosure principle dictates that companies disclose circumstances and events that matter to financial statement users.
The major constraints are materiality and conservation.

TRUE-FALSE STATEMENTS 1.______ Cash and supplies are both classified as current assets.

2.______ Stockholders’ equity is divided into two parts: common stock and retained earnings. 3.______ It is possible for an asset to be a current asset even though the expected conversion of that asset into cash is to be longer than one year or the normal operating cycle. 4.______ Profitability means having enough funds on hand to pay debts when they fall due.

5.______ The retained earnings statement describes the changes in retained earnings during the period. 6.______ The retained earnings statement is more comprehensive than the statement of shareholders equity.

7.______ The excess of current assets over current liabilities is called working capital. 8.______ The current ratio takes into account the composition of current assets. 9.______ Solvency ratios measure the short-term ability of the company