Accounting Concepts * Flashcards
Generally speaking, _________________ is the proper basis for recording a piece of equipment on a company’s books.
Historical Cost
Although some exceptions exist, generally historical cost is the proper basis for the recording of assets, expenses, equities, etc. For example, a piece of operational machinery should be shown on the balance sheet at initial acquisition cost (historical cost) and not at current market value, appraised value, or an estimated replacement value.
Income Statement vs Balance Sheet vs Statement of Owner’s Equity
Whereas the balance sheet shows a company’s financial position at a specific point in time, the income statement details how much profit (or loss) a company earned during a period of time, such as a quarter or a year.
The statement of owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet. The statement of cash flows reports a company’s sources and uses of cash during a particular period of time.
It is considered acceptable practice to deviate from GAAP in which of the following circumstances?
The question of when it is appropriate to stray from GAAP is a matter of professional judgment; there is no clear-cut set of circumstances that justify such a departure. It can be assumed that adherence to GAAP will almost always result in financial statements that are fairly presented. However, the standard setting bodies recognize that, upon occasion, there might be an unusual circumstance when the literal application of GAAP would render the financial statements misleading. In these cases, a departure from GAAP is the proper accounting treatment.
Departures from GAAP can be justified in the following circumstances:
• It is common practice in the entity’s industry for a transaction to be reported a particular way.
• The substance of the transaction is better reflected (and, therefore, the financial statements are more fairly presented) by not strictly following GAAP.
• If a transaction is considered immaterial (i.e., it would not affect a decision made by a prudent reader of the financial statements), then it need not be reported.
• There is concern that assets or income would be overstated (the conservatism constraint requires that when there is any doubt, one should avoid overstating assets and income).
• An accountant may depart from GAAP if the results of departure appear reasonable under the circumstances, especially when strict adherence to GAAP will produce unreasonable results and the departure is properly disclosed.
If a fraudster wanted to conceal the misappropriation of cash, which of the following actions would result in a balanced accounting equation?
The accounting equation, Assets = Liabilities + Owners’ Equity, is the basis for all double-entry accounting. If an asset (e.g., cash) is stolen, the equation can be balanced by increasing another asset, reducing a liability, reducing an owners’ equity account, reducing revenues (and thus retained earnings), or creating an expense (and thus reducing retained earnings).
When looking at a set of financial statements, on which statement would you find notes payable, current assets, retained earnings, and accumulated depreciation?
Notes payable, current assets, retained earnings, and accumulated depreciation can all be found on the balance sheet. The balance sheet is an expansion of the accounting equation, Assets = Liabilities + Owners’ Equity. That is, it lists a company’s assets on one side and its liabilities and owners’ equity on the other side. Assets are classified as either current or noncurrent. Current assets consist of cash or other liquid assets that are expected to be converted to cash, sold, or used up, usually within a year or less. Current assets listed on the balance sheet include cash, accounts receivable, inventory, supplies, and prepaid expenses.
Following the current assets are the long-term assets, or those assets that will likely not be converted to cash in the near future, such as fixed assets and intangible assets. A company’s fixed assets are presented net of accumulated depreciation, an amount that represents the cumulative expense taken for wear-and-tear on a company’s property.
Liabilities are presented in order of maturity. Like current assets, current liabilities are those obligations that are expected to be paid within one year, such as accounts payable (the amount owed to vendors by a company for purchases on credit), accrued expenses (e.g., taxes payable or salaries payable), and the portion of long-term debts that will come due within the next year. Those liabilities that are not due for more than a year are listed under the heading long-term liabilities. The most common liabilities in this group are bonds, notes, and mortgages payable.
Which of the following types of accounts are increased by credits?
Entries to the left side of an account are referred to as debits, and entries to the right side of an account are referred to as credits. Debits increase asset and expense accounts, whereas credits decrease these accounts. On the other side of the equation, credits increase liabilities, revenue, and owners’ equity accounts. Conversely, debits decrease liabilities, revenues, and owners’ equity.
If a fraudster wanted to conceal the removal of a liability from the books, which of the following actions would balance the accounting equation?
The accounting equation, Assets = Liabilities + Owners’ Equity, is the basis for all double-entry accounting. Suppose that in order to make an organization appear that it has less debt, an accountant fraudulently removes a liability. This would leave the accounting equation unbalanced since the assets side would be greater than liabilities plus owners’ equity. In this particular case, the equation can be balanced by decreasing an asset, increasing a different liability, increasing an owners’ equity account, increasing revenues (and thus retained earnings), or reducing an expense (and thus increasing retained earnings). Increasing an asset would only make the equation further out of balance.
At the end of each fiscal year, the accounts reflected on the income statement are reduced to a zero balance? T/F
The accounts reflected on the income statement are temporary; at the end of each fiscal year, they are reduced to a zero balance (closed), with the resulting net income (or loss) added to (or subtracted from) retained earnings on the balance sheet.
The statement of owners’ equity acts as the connecting link between which two financial statements?
The statement of owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet. Because it shows how the amounts on the income statement flow through to the balance sheet, it acts as the connecting link between the two statements. The balance of the owners’ equity at the beginning of the year is the starting point for the statement. The transactions that affect owners’ equity are listed next and are added together. The result is added to (or subtracted from, if negative) the beginning-of-the-year balance, which provides the end-of-the-year balance for total owners’ equity.
Purpose of Cash flow and period?
The statement of cash flows reports a company’s sources and uses of cash during the accounting period. This statement is often used by potential investors and other interested parties in tandem with the income statement to determine the true financial performance of a company during the period being reported.
The statement of cash flows is broken down into three sections:
cash flows from operating activities,
cash flows from investing activities, and cash flows from financing activities.
The balance sheet shows a company’s financial position at a specific point in time.
What is the matching principle
The matching principle requires that expenses be recorded in the same accounting period as the revenues they help generate. Estimates, accruals, and allocations are often needed to meet this requirement. When a sale is recorded, the appropriate charges for cost of goods sold, or other expenses directly corresponding to the sale, should be recorded in the same accounting period. In this example, since the expenses will not be incurred until David caters the event in February, the revenue David received should not be recorded until February as well.
Going concern
Management is required to provide disclosures when existing events or conditions indicate that it is more likely than not that the entity might be unable to meet its obligations within a reasonable period of time after the financial statements are issued. There is an assumption that an entity will continue as a going concern; that is, the life of the entity will be long enough to fulfill its financial and legal obligations. Any evidence to the contrary must be reported in the entity’s financial statements.
Income Statement (basic) layout
Two basic types of accounts are reported on the income statement—revenues and expenses. Revenues represent amounts received from the sale of goods or services during the accounting period. Most companies present net sales as the first line item on the income statement. The term net means that the amount shown is the company’s total sales minus any sales refunds, returns, discounts, or allowances.
From net sales, an expense titled cost of goods sold or cost of sales is deducted. Regardless of the industry, this expense denotes the amount a company spent (in past, present, and/or future accounting periods) to produce the goods or services that were sold during the current period. The difference between net sales and cost of goods sold is called gross margin, or gross profit, which represents the amount left over from sales to pay the company’s operating expenses.
Statement of Owner’s Equity
The statement of owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet. Because it shows how the amounts on the income statement flow through to the balance sheet, it acts as the connecting link between the two statements. The balance of the owners’ equity at the beginning of the year is the starting point for the statement. The transactions that affect owners’ equity are listed next and are added together. The result is added to (or subtracted from, if negative) the beginning-of-the-year balance, which provides the end-of-the-year balance for total owners’ equity.
The statement of owners’ equity is a summary overview of the effects of owner investment and company net income on the owners’ equity balance. It does not name any shareholders or their individual ownership stake in the company.
Some companies present a statement of retained earnings rather than a statement of owners’ equity. Similar to the statement of owners’ equity, the statement of retained earnings starts with the retained earnings balance at the beginning of the year.
Which of the following types of accounts are increased by credits? A. Revenue B. Liability C. Owners’ equity D. All of the above
D
Credits decrease asset and expense accounts. T/F
T
Which of the following statements is TRUE regarding the balance sheet?
A. The balance sheet shows the financial performance of a company over a certain period of time, such as a quarter or a year.
B. The accounts that appear on the balance sheet include revenues and expenses.
C. Balance sheets are usually manipulated by understating assets or overstating liabilities.
D. Assets are generally presented on the balance sheet in order of liquidity.
D
Which of the following statements is NOT true regarding the statement of cash flows?
A. The statement of cash flows shows a company’s financial position at a specific point in time.
B. The statement of cash flows reports a company’s sources and uses of cash during the accounting period.
C. There are three types of cash flows: cash flows from operating activities, from investing activities, and from financing activities.
D. The statement of cash flows is often used in tandem with the income statement to determine a company’s true financial performance.
A
If a fraudster wanted to conceal the removal of a liability from the books, which of the following actions would NOT balance the accounting equation? A. Increasing a different liability B. Increasing an asset C. Increasing revenue D. Increasing owners’ equity
B
Which of the following types of accounts are increased by credits? A. Revenue B. Liability C. Owners’ equity D. All of the above
D
If a fraudster wanted to conceal the misappropriation of cash, which of the following actions would NOT result in a balanced accounting equation? A. Decreasing another asset B. Creating an expense C. Reducing owners’ equity D. Decreasing a liability
A
Which GAAP principle requires corresponding expenses and revenue to be recorded in the same accounting period? A. Full disclosure B. Consistency C. Matching D. Conservatism
C
The assumption that a business will continue indefinitely is reflected in the accounting concept of: A. Cost B. Objective evidence C. Materiality D. Going concern
D (verify)
The concept of consistency prohibits any change in an accounting principle previously employed. T/F
F
Entities should employ consistent accounting procedures from period to period. However, the concept of consistency does not completely prohibit changes in the accounting principles used. Changes are permissible when it is believed that the use of a different principle will result in a more fair financial presentation of the entity. The change in accounting principle must be justifiable, however; the desire to project an artificially strong performance, for example, is not a justifiable reason for a change in accounting principle.
Examples of changes in accounting principles include a change in the method of inventory pricing, a change in the depreciation method for previously recorded assets, and a change in the method of accounting for long-term construction contracts. The disclosure for a change in accounting principles should include the justification for the change, and should explain why the newly adopted principle is preferable.
All of the following are common methods that fraud examiners can use to uncover an employee who has an undisclosed financial interest with an outside vendor EXCEPT:
A. Review tips and complaints from employees or vendors.
B. Compare customer account balances to billing files.
C. Compare vendor addresses with employee addresses.
D. Review exit interviews.
B
Which of the following is an example of an "off-book" fraud? A. Skimming B. Billing schemes C. Cash larceny D. Ghost employee schemes
A
Performing a physical inventory count is an effective way to detect a skimming scheme. T/F
T
Skimming schemes can involve the theft of cash sales or the theft of accounts receivable payments. T/F
T
