Accounting Concepts

Question 1

When can departures from GAAP be justified?

Answer 1

• common practice in the entity’s industry for a transaction to be reported in 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, then it need not be reported.
• There is concern that assets or income would be overstated and expenses or liabilities would be understated
• when strict adherence to GAAP will produce misleading financial statements and the departure is properly disclosed.

Question 2

What is the accounting equation?

Answer 2

Assets = Liabilities + Owners’ Equity

asset and expense accounts - DEBITS INCREASE, CREDITS DECREASE

Liability/revenue/OE - CREDITS INCREASE, DEBITS DECREASE

If ASSET Stolen:

• increase another asset
• reduce liability
• reduce owners equity
• reduce revenue
• create expense

Question 3

WHAT IS HISTORICAL COST?

Answer 3

• property, plant, and equipment be initially recognized at historical cost
• Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition

Question 4

Cash-basis vs. Accrual Basis

Answer 4

Cash basis requires recording revenue and expenses when cash exchanges hands.

Accrual Basis requires revenues to be recorded when they are earned (i.e. goods delivered, services rendered). Expenses are recorded in the same period as the respective revenue.

Question 5

Statement of Cash Flows

Answer 5

a. Reports a company’s sources and uses of cash during the accounting period
b. Often used in tandem with income statement to determine company’s true financial performance
c. Broken down to three sections:
i. Cash flow from OPERATING ACTIVITIES
ii. Cash flow from INVESTING ACTIVITIES
iii. Cash flow from FINANCING ACTIVITIES

Question 6

GAAP PRINCIPLES

Answer 6

1. Comparability
   ○ enables users to identify and understand similarities in, and differences among, items.
   
   2. Consistency
      ○ use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities.
   3. Matching
      ○ involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events
   4. Going Concern
      ○ Disclosures to be provided when existing events or conditions indicate that it is more likely than not that the entity might be unable to meet its obligations.. There is an underlying assumption that an entity will continue as a going concern. Any evidence to the contrary must be reported in the entity’s financial statements.
   5. Faithful Representation
      ○ Qualities of perfectly faithful representation: complete, neutral, and free from error.
      § all information necessary to understand the data presented.
      § without bias in the selection or presentation of financial information.
      § no material errors or omissions in the financial reporting data

Question 7

Change in accounting principles?

Answer 7

ONLY if the change is required by a standard or interpretation or results in the financial statements providing more reliable and relevant information about the effects of transactions; other events; or conditions on the entity’s financial position, financial performance, or cash flows. The entity’s financial statements must include full disclosure of any such changes.
- 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
○ a change in the method of accounting for long-term construction contracts.