Chapter 2 Investing and Financing Decisions and the Accounting System ANSWERS TO QUESTIONS 1. The primary objective of financial reporting for external users is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. These users are expected to have a reasonable understanding of accounting concepts and procedures. Usually, they are interested in information to assist them in projecting future cash inflows and outflows of a business. 2. (a) An asset is a probable future economic benefit owned or controlled by the entity as a result of past transactions. (b) A current asset is an asset that will be used or turned into cash within one year; inventory is always considered a current asset regardless of how long it takes to produce and sell the inventory. (c) A liability is a probable future sacrifice of economic benefits of the entity arising from present obligations as a result of a past transaction. (d) A current liability is a liability that will be settled by providing cash, goods, or other services within the coming year. (e) Additional paid-in capital is the owner-provided financing to the business that represents the excess of the amount received when the common stock was issued over the par value of the common stock. (f) Retained earnings are the cumulative earnings of a company that are not distributed to the owners and are reinvested in the business. Financial Accounting, 10/e 2-1 C 2020 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3. (a) The separate entity assumption requires that business transactions are separate from the transactions of the owners. For example, the purchase of a truck by the owner for personal use is not recorded as an asset of the business. (b) The monetary unit assumption requires information to be reported in the national monetary unit without any adjustment for changes in purchasing power. That means that each business will account for and report its financial results primarily in terms of the national monetary unit, such as Yen in Japan and Australian dollars in Australia. (c) Under the going concern assumption, businesses are assumed to operate into the foreseeable future. That is, they are not expected to liquidate. (d) Historical cost is a measurement model that requires assets to be recorded at the cash-equivalent cost on the date of the transaction. Cash- equivalent cost is the cash paid plus the dollar value of all noncash considerations. 4. Accounting assumptions are necessary because they reflect the scope of accounting and the expectations that set certain limits on the way accounting information is reported. 5. An account is a standardized format used by organizations to accumulate the dollar effects of transactions on each financial statement item. Accounts are necessary to keep track of all increases and decreases in the fundamental accounting model. 6. The fundamental accounting model is provided by the