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4. Explain how the statement of financial position, often referred to as the balance sheet, is an
expansion of the basic accounting equation.
5. Explain how the income statement reports an enterprise’s financial performance for a period
of time in terms of the relationship of revenues and expenses.
6. Explain how the statement of cash flows presents the change in cash for a period of time in
terms of the company’s operating, investing, and financing activities.
7. Explain important relationships among the statement of financial position, income statement,
and statement of cash flows, and how these statements relate to each other.
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8. Explain common forms of business organization – sole proprietorship, partnership,
corporation – and demonstrate how they differ in terms of their presentation in the statement
of financial position.
9. Discuss the importance of financial statements to a company and its investors and creditors
and why management may take steps to improve the appearance of the company in its
financial statements.
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Chapter 02 - Basic Financial Statements
Homework Assignment
(To Be Completed Prior to Class)
Class Topical
Meetings Outline Discussion Brief
on Chapter Coverage Questions Exercises Exercises Problems Critical
Thinking
Cases
1 A-D 3, 4, 5, 8 1, 3,4 1, 4, 6, 1, 3, 6 1
2 E–I 9, 14, 15 7, 9, 10 11, 12, 13 7, 8, 9 3
The chapter introduces technical material, including the balance sheet, income statement,
statement of cash flows, several generally accepted accounting principles, the accounting equation,
and the effects of business transactions upon assets, liabilities, and owners' equity.
Our objectives in presenting this chapter are:
1 Describe the nature of financial statements. Explain the role of generally accepted
accounting principles in this process.
2 Illustrate and explain a balance sheet. Define the terms assets, liabilities, and owners' equity,
and discuss the basic accounting principles relating to asset valuation. Discuss the uses and
limitations of this financial statement.
3 Introduce the accounting equation and illustrate the effects of business transactions upon
this equation and upon a balance sheet.
4 Introduce the income statement, emphasizing the nature of revenues and expenses.
5 Introduce the statement of cash flows and distinguish among operating, investing, and
financing activities.
2-4
General comments
Introducing the financial statements Our overriding objective in this chapter is to introduce
students to the balance sheet, income statement, and statement of cash flows. We find Problem 8
useful for this purpose. Exercise 1 defining assets and liabilities, stimulates student interest when
discussed in class. Also, it is short enough that they can be discussed without having been assigned
as homework. We also recommend Problem 9 or 10 for initiating a lively classroom discussion of
many of the concepts introduced in this chapter.
In covering Chapter 2, we like to continue the overview of the financial reporting process
begun in Chapter 1. Cases 2 and 6 provide a useful framework for this discussion, but there is not
enough time for both of them. Therefore, we rotate these cases in and out of our assignment
schedules. If Case 6 is discussed, it would be appropriate to explain, in simple terms, the meaning
and significance of debt covenants, in order to cultivate student appreciation of the importance of
the accounting issues in this case.
Have you considered using annual reports? One method of bringing the "real world" into the
classroom is through the use of annual reports. Annual report information can be obtained through
the SEC’s EDGAR database available on the Internet, or from individual company home pages.
We encourage students to review these reports throughout the course and to note any similarities
and variations between their reports and the textbook treatment of various topics. These
comparisons increase students' interest in the course, prompt interesting questions, and
demonstrate the diversity, which exists in practice.
Any annual report works fine. In fact a diversity of reports sparks comparisons and discussions
among students, and prevents one company from being asked to supply an unreasonable number
of reports. The reports need not be current to be useful. Once obtained, they may be passed on to
future students for at least several semesters.
An aside In discussing the valuation of assets in the balance sheet of a business, the text stresses
the cost principle. Therefore, the statement is made that the balance sheet of a business does not
show "how much the company is worth." A different standard prevails, however, in the
preparation of personal financial statements for an individual. In an individual's personal balance
sheet, generally accepted accounting principles require assets to be valued at estimated market
values. In addition, the estimated income tax liability, which would result from selling the assets
at these values also, is included in an individual's balance sheet. Thus, the owners' equity section
of a personal balance sheet shows the individual's net worth.
Why have we not discussed personal financial statements in the text? The answer is that very
few individuals prepare personal financial statements in conformity with generally accepted
accounting principles. Most individual financial statements are prepared in conjunction with loan
applications. In these cases, the lender usually supplies its own preprinted forms, which specify
the lender's standards for the valuation of assets and liabilities. These standards often vary from
generally accepted accounting principles. For example, most lenders do not ask a borrower to
estimate the income tax liability, which would result from liquidating appreciated assets at their
market values.
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ordinances of any State, and on which there is no white male adult
not liable to military service, and in States having no such law, one
person, as agent, owner, or overseer on such plantation of twenty
negroes, and on which there is no white male adult not liable to
military service;’ and also the following clause in said act, to wit: ‘and
furthermore, for additional police of every twenty negroes, on two or
more plantations, within five miles of each other, and each having
less than twenty negroes, and on which there is no white male adult
not liable to military duty, one person, being the oldest of the owners
or overseers on such plantations,’ be and the same are hereby
repealed; and the persons so hitherto exempted by said clauses of
said act are hereby made subject to military duty in the same manner
that they would be had said clauses never been embraced in said
act.”
After the President had issued his first call, Douglas saw the
danger to which the Capitol was exposed, and he promptly called
upon Lincoln to express his full approval of the call. Knowing his
political value and that of his following Lincoln asked him to dictate
a despatch to the Associated Press, which he did in these words, the
original being left in the possession of Hon. George Ashmun of
Massachusetts:
“April 18, 1861, Senator Douglas, called on the President, and had
an interesting conversation, on the present condition of the country.
The substance of it was, on the part of Mr. Douglas, that while he was
unalterably opposed to the administration in all its political issues,
he was prepared to fully sustain the President, in the exercise of all
his Constitutional functions, to preserve the Union, maintain the
Government, and defend the Federal Capitol. A firm policy and
prompt action was necessary. The Capitol was in danger, and must
be defended at all hazards, and at any expense of men and money.
He spoke of the present and future, without any reference to the
past.”
Douglas followed this with a great speech at Chicago, in which he
uttered a sentence that was soon quoted on nearly every Northern
tongue. It was simply this, “that there now could be but two parties,
patriots and traitors.” It needed nothing more to rally the Douglas
Democrats by the side of the Administration, and in the general
feeling of patriotism awakened not only this class of Democrats, but
many Northern supporters of Breckinridge also enlisted in the Union
armies. The leaders who stood aloof and gave their sympathies to the
South, were stigmatized as “Copperheads,” and these where they
were so impudent as to give expression to their hostility, were as
odious to the mass of Northerners as the Unionists of Tennessee and
North Carolina were to the Secessionists—with this difference—that
the latter were compelled to seek refuge in their mountains, while the
Northern leader who sought to give “aid and comfort to the enemy”
was either placed under arrest by the government or proscribed
politically by his neighbors. Civil war is ever thus. Let us now pass to
The first session of the 37th Congress began July 4, 1861, and
closed Aug. 6. The second began December 2, 1861, and closed July
17, 1862. The third began December 1, 1862 and closed March 4,
1863.
All of these sessions of Congress were really embarrassed by the
number of volunteers offering from the North, and sufficiently rapid
provision could not be made for them. And as illustrative of how
political lines had been broken, it need only be remarked that
Benjamin F. Butler, the leader of the Northern wing of Breckinridge’s
supporters, was commissioned as the first commander of the forces
which Massachusetts sent to the field. New York, Pennsylvania, Ohio
—the great West—all the States, more than met all early
requirements. So rapid were enlistments that no song was as popular
as that beginning with the lines:
“We are coming, Father Abraham,
Six hundred thousand strong.”
The first session of the 37th Congress was a special one, called by
the President. McPherson, in his classification of the membership,
shows the changes in a body made historic, if such a thing can be, not
only by its membership present, but that which had gone or made
itself subject to expulsion by siding with the Confederacy. We quote
the list so concisely and correctly presented:
SENATORS.
REPRESENTATIVES.
MEMORANDUM OF CHANGES.
IN SENATE.
IN HOUSE OF REPRESENTATIVES
COMPENSATED EMANCIPATION
To the President:
Slaves.
Kentucky had 225,490
Maryland 87,188
Virginia 490,887
Delaware 1,798
Missouri 114,965
Tennessee 275,784
C. A. Wickliffe, Ch’n,
Garrett Davis,
R. Wilson,
J. J. Crittenden,
John S. Carlile,
J. W. Crisfield,
J. S. Jackson,
H. Grider,
John S. Phelps,
Francis Thomas,
Chas. B. Calvert,
C. L. Leary,
Edwin H. Webster,
R. Mallory,
Aaron Harding,
James S. Rollins,
J. W. Menzies,
Thomas L. Price,
G. W. Dunlap,
Wm. A. Hall.
Others of the minority, among them Senator Henderson and
Horace Maynard, forwarded separate replies, but all rejecting the
idea of compensated emancipation. Still Lincoln adhered to and
advocated it in his recent annual message sent to Congress, Dec. 1,
1862, from which we take the following paragraphs, which are in
themselves at once curious and interesting:
“We have two million nine hundred and sixty-three thousand
square miles. Europe has three million and eight hundred thousand,
with a population averaging seventy-three and one-third persons to
the square mile. Why may not our country, at some time, average as
many? Is it less fertile? Has it more waste surface, by mountains,
rivers, lakes, deserts, or other causes? Is it inferior to Europe in any
natural advantage? If, then, we are at some time to be as populous as
Europe, how soon? As to when this may be, we can judge by the past
and the present; as to when it will be, if ever, depends much on
whether we maintain the Union. Several of our States are already
above the average of Europe—seventy-three and a third to the square
mile. Massachusetts has 157; Rhode Island, 133; Connecticut, 99;
New York and New Jersey, each, 80. Also two other great states,
Pennsylvania and Ohio, are not far below, the former having 63 and
the latter 59. The states already above the European average, except
New York, have increased in as rapid a ratio, since passing that
point, as ever before; while no one of them is equal to some other
parts of our country in natural capacity for sustaining a dense
population.
“Taking the nation in the aggregate, and we find its population and
ratio of increase, for the several decennial periods, to be as follows:
1870 42,323,341
1880 56,967,216
1890 76,677,872
1900 103,208,415
1910 138,918,526
1920 186,984,335
1930 251,680,914