Chapter 1 - Conceptual Framework

and Financial Statements

Directed Reading Worksheet

Part I: Understand the role of accounting in communicating financial information (LO1)

1. What were net income for The Alibaba Group, for its year ended March 31, 2016? For its year
ended March 31, 2015? On what statement do you find this information? Using Exhibit 1-9
Consolidated income statement

2. What is the reason for having financial statements? Financial statements are the business
documents that companies use to report the results of their activities to various user groups, which
can include managers, investors, creditors, and regulatory agencies. In turn, these parties use the
reported information to make a variety of decisions, such as whether to invest in or loan money to
the company, amongst many others.
Companies have financial statements in order to report the results of their business activities
to various groups of users, such as managers, investors, creditors, and regulatory agencies.

3. ______Accounting___________ is the language of communication in all businesses. It records and

measures business activities, processes data into information, and communicates this information to
decision makers. Exhibit 1-1 shows how business activities are recorded in the accounting system,
which, in turn, produces financial reports that help decision making in business activities. Business
activities are recorded in accounting system. Produces financial statements. Financial statements
influence business activities. Flow of accounting information

4. What two branches of accounting are based on whether the user is external or internal?
Financial accounting provides information to decision makers
 outside the reporting entity. These are investors, creditors, government agencies, and the
public. User is external
Management accounting provides information for Alibaba’s managers. Examples of
management accounting information include budgets, forecasts, and projections that are used
in making strategic decisions for the entity. Managers of Alibaba have the ability to determine
the form and content of financial information in order to meet their own needs. Internal
information must still be reliable and relevant for their decision needs. User is internal

5. A ___proprietorship________________ form of business organization consists of a single owner

and the owner is personally liable for all of the business’s debts. Proprietorships tend to be small
retail stores or individual providers of professional services—physicians, attorneys, software
programmers, or accountants. Legally, the business is the proprietor, and the proprietor is
personally liable for all the business’s debts. But for accounting purposes, a proprietorship is a
distinct entity, separate from its proprietor. Thus, the business records should not include the
proprietor’s personal finances.

6. Income and loss from the ____partnership__________________ form of business organization

“flows through” to the owners; each owner canmake agreements that legally bind (baglaayici) all
partners into unlimited debt. Quite risky

7. When organized as a _____corporation__________________________, the shareholders have no

personal obligation for the corporation’s debts and have limited liability. A corporation is a business
owned by the shareholders, who own shares representing ownership in the corporation. One of the
major advantages of doing business in the corporate form is the ability to raise capital from
issuance of shares to the public.

8. Who (or what) ultimately controls a corporation?

Shareholders who own shares in the corporation. All types of entities (individuals, partnerships,
corporations, or other types) may be shareholders in a corporation. Unlike proprietorships and
partnerships, a corporation is legally distinct from its owners. The corporation is like an
 artificial person and possesses many of the same rights that a person has. The shareholders
have no personal obligation for the corporation’s debts and have limited liability. Ultimate
control of a corporation rests with the shareholders, who generally get one vote for each
share they own. In general, shareholders elect the board of directors, which sets policy and
appoints management officers, such as the chief executive officer (CEO), chief operating officer
(COO), and chief financial officer (CFO)

Part II: Understand the underlying accounting concepts in the IFRS Conceptual Framework (LO2)
9. Two professional frameworks for the measurement and disclosure of financial information are:

a. Generally Accepted Accounting Principles (GAAP)formulated by (FASB) Financial Accounting

Standards Board
b. International Financial Reporting Standards (IFRS) formulated by (IASB) International
Accounting Standards Board
in the long run, the global use of IFRS should reduce the costs of doing business globally
The Conceptual Framework’s focus is on general purpose financial statements, OBJECTIVE OF
FINANCIAL REPORTING To provide financial information that is useful to existing and potential
investors, lenders, and other creditors in making decisions about providing resources to the entity

General purpose financial reports which provide information on the entity’s economic resources, claims,
and changes in resources and claims

While financial statements can be used to help users assess the financial health of an entity, as well as
its strengths and weaknesses, they are not designed to show the “value” of an entity;

10. 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.
11. 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: would make sense to the reasonably informed user of information

Part III: Obtain insights into business operations through financial statements (LO3)
12. Assets are economic resources that are expected to produce a ____benefit______ in the future.
Liabilities are debts that are payable to _____outsıders____. Equity represents the ___insider____
claims of a business.
Assets are economic resources controlled by the entity that are expected to produce a benefit in
the future. Examples of assets include cash, inventory, account receivables (money owed to the
entity by its debtors), machinery, equipment, and properties.
Liabilities are present obligations of the entity that are expected to result in an outflow of
economic benefits from the entity, i.e., something the company owes (to a party outside the
company). Examples of liabilities include bank loans, accounts payable (money owed by the
entity to its creditors), and other obligations.
■ Equity is what’s left of the assets after deducting liabilities; it represents shareholder’s residual
claim to the entity’s assets. You will find two major sub-parts in the equity section: share capital
and retained earnings. Share capital is the amount shareholders have invested in the entity (by
purchasing shares or stock), and retained earnings is the amount earned by income-producing
activities and kept for use in the business.
■ Income refers to increases in economic benefits during an accounting period, i.e., increases in
assets or decreases in liabilities that result in an increase in equity, other than those related to
transactions with shareholders. The Conceptual Framework further separates income into
revenue and gains. Revenue arises from the ordinary course of business (such as sales revenue),
whereas gains are typically outside the ordinary course of business (such as gain on disposal of a
subsidiary).
Expenses are decreases in economic benefits during an accounting period, i.e., decreases in
assets or increases in liabilities that result in a decrease in equity, other than those related to
transactions with shareholders. Similarly, expenses can be incurred in the ordinary course of
business (such as salaries and wages, rent, and other expenses), whereas losses may or may not
be in the ordinary course of business, such as loss on disposal of a longterm asset). Similar to
gains, losses are reported on a net basis.
13. What is the accounting equation?
Assets = Liabilities + Equity, or alternatively, Assets − Liabilities = Equity. As Exhibit 1-4 shows,
the two sides must be equal. This is the underlying premise of the double-entry system of
bookkeeping where total debits will always equal total credits

14. What are the two main subparts of shareholders’ 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
The main difference is that paid-in capital comes from the shareholders while retained
earnings is from the operations of the business.

15. The three major types of transactions that affect retained earnings are __revenues________,
__expenses_________, and ________dıvıdends______. Paying employee salaries would
____decrease____ retained earnings.

16. Dividends ( ARE NOT) expenses. They (NEVER ) affect net income.

17. How is retained earnings calculated?

Retained earnings = Revenues – Expenses – Dividends

Or
Retained earnings = Net income (net loss) – Dividends
Retained earnings are a percentage of net income and are retained by the company for
reinvestment or debt payment. A successful business usually pays dividends to shareholders
 (when there is an increase in retained earnings) as a return on their investments, usually in the
form of cash. Dividends are recorded as direct reductions of retained earnings. Remember that
just as capital contribution from shareholders to the company is not income, dividend
distribution is not an expense and will never affect net income
When total revenues exceed total expenses, the result is called net income, or net profit. When
expenses exceed revenues, the result is called net loss. Net income is, thus, the profit left over
after subtracting expenses and losses from revenues and gains.
Total Revenue and Gains - Total Expenses and Losses = Net Income (or Loss

Part IV: Identify financial statements and their inter-relationships (LO4)

18. You can determine how well the company performed during the year by looking at its
_________ıncome statement____ ________________. You can determine a company’s financial
position by looking at its __________balance sheet ___ ________________.

19. The three sources (uses) of cash flows include __operating_____. investing___________, and
_____financing____ activities.

20. What is the single most important item in the financial statements?

Net income
21. Operating expenses are the costs of every day operations that are not directly related to
merchandise purchases and occupancy. TRUE
22. What does the statement of the retained earnings show about a company?
The statement of retained earnings shows the portion of net income that a company has
retained over the years. If the company has been profitable, it will have a positive balance in
retained earnings. If it has had losses, then its retained earnings will be in a deficit. The
statement of retained earnings also shows if the company has distributed dividends
23. List and describe the three items (sections) on a balance sheet.
a. Assets: Assets are economic resources that are expected to provide a future benefit. They are divided
into current and long-term assets.
b. Liabilities: Liabilities are debts that the company owes. They are also divided into current and
long-term depending on when they become due.
c. Shareholders’ Equity: The claim of the owners or shareholders’ to the assets of the business.

24. Put the following assets in order of liquidity: equipment, cash, inventory, and short-term
investments.

Cash, Short-term investments, Inventory, Equipment

25. When the term “net” is used on a financial statement regarding property and equipment, it means
that the historical acquisition cost of the assets has been reduced by ___accumulated
depreciation________ ____________.

26. Operating activities show how the company operates by selling _______ and __________ to
customers. Investing activities show a company’s investment in ______-_____ ___________.
Financing activities include _______________________________________________.

27. The income statement is the only financial statement to report __revenues__________ and
______expenses____.

28. If expenses exceed revenues, the company will report a ___net loss___ _______.

29. Describe how to construct a statement of retained earnings.

 A statement of retained earnings starts with the beginning retained earnings balance. Then, net
income is added or net loss is subtracted. Next, dividends are subtracted. The final line is then
calculated, to give us ending retained earnings

30. List five examples of accounts that would be listed on the balance sheet.

31. You can determine if a company is able to pay its current and long-term liabilities by comparing
______ _total assets______ to _______ ___total liabilities_______.

32. If you were considering investing in The Alibaba Group, what should you look for?

 Can the company sell its services and products?  Look at revenue on the income statement
 What are the main income measures and trends?  Calculate and analyze gross profit,
operating income, and net income
 What percentage of revenue ends up as profit?  Divide net income by sales revenue
 Can the company pay its current and long-term liabilities?  Compare assets to liabilities on
the balance sheet (both current and long-term)
 Where is the company’s cash coming from and how is it being used?  Examine the statement
of cash flows

Part V: Understand the role of ethics in accounting (LO5)

33. Describe ethics in your own words.

34. List and describe the three factors that influence accounting decisions.

a. _________________________________________
 b. _________________________________________

c. _________________________________________

35. The four core values of the Business Ethics Leadership Alliance include _________ __________,
transparency, __________ __________, and accountability.

36. What is the best decision framework for making ethical judgments?

The Statement of Changes in Equity Shows a Company’s Transactions with its Owners Recall that
the equity is the owner’s residual interest in the entity after deducting liabilities. Profits that a
company generates ultimately belong to the owners of the company
financial position is always for a specific point in time, unlike an Income Statement, which covers a
period of time