Accounting

CHAPTER 2

A Further Look at Financial Statements

ANSWERS TO QUESTIONS

 1. A company’s operating cycle is the average time that is required to go from cash to cash in prod-ucing revenue.

 2. Current assets are assets that a company expects to convert to cash or use up within one year of the balance sheet date or the company’s operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.

 3. Long-term investments are investments in stocks and bonds of other companies where the conversion into cash is not expected within one year or the operating cycle, whichever is longer and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

 4. Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.

 5. The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business.

 6. (a) Julia is not correct. There are three characteristics: liquidity, profitability, and solvency.

(b) The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

 7. (a) Liquidity ratios:  Working capital and current ratio.

(b) Solvency ratios:  Debt to total assets and free cash flow.

(c) Profitability ratio:  Earnings per share.

 8. Debt financing is riskier than equity financing because debt must be repaid at specific...