Accounting Principles

Question 1

What are the common rules that apply to financial statements distributed by a U.S. company?

Answer 1

Accounting principles, generally accepted accounting principles (GAAP), or US GAAP

These rules allow external users to make comparisons between companies’ financial statements.

Question 2

Who has developed and maintained US GAAP since 1974?

Answer 2

Financial Accounting Standards Board (FASB)

The FASB is a non-government, not-for-profit organization.

Question 3

What is the Accounting Standards Codification?

Answer 3

An electronic database containing the official accounting standards applicable to financial reporting of U.S. companies

Launched by the FASB in 2010.

Question 4

What is the role of the Securities and Exchange Commission (SEC) in relation to U.S. corporations?

Answer 4

U.S. corporations with capital stock trading on a stock exchange must comply with SEC regulations

The SEC is a U.S. government agency.

Question 5

What is the economic entity assumption?

Answer 5

Keeps business transactions of a sole proprietorship separate from the sole proprietor’s personal transactions

Financial statements can also be prepared for a group of separate legal corporations controlled by one corporation.

Question 6

What does the monetary unit assumption state for U.S. companies?

Answer 6

Allows expression of a company’s assets as dollar amounts, assuming the U.S. dollar does not lose purchasing power over time

This affects how historical costs are reported.

Question 7

What does the going concern assumption imply?

Answer 7

The accountant believes that the company will not be liquidated in the foreseeable future

This allows for reporting most assets at their historical cost.

Question 8

What is the time period (or periodicity) assumption?

Answer 8

Assumes a company’s ongoing operations can be divided into distinct time periods

This is often done in months, quarters, and years.

Question 9

What does the cost principle state?

Answer 9

Transactions are recorded at the cash (or equivalent) amount at the time of the transaction

Most valuable assets may not be recorded or reported under this principle.

Question 10

What is required by the full disclosure principle?

Answer 10

A company must provide sufficient information for an intelligent user to make informed decisions

This often includes disclosures and schedules in the notes to the financial statements.

Question 11

When should revenues be recognized according to the revenue recognition principle?

Answer 11

When they are earned

This can occur before, at the time of, or after receiving payment.

Question 12

What is the matching principle or expense recognition?

Answer 12

Expenses are recognized based on a cause-and-effect relationship with revenues

If unclear, expenses are reported in the period they are used up.

Question 13

Define materiality in accounting.

Answer 13

An accounting principle can be ignored if the amount is insignificant

Large companies may expense inexpensive equipment immediately.

Question 14

What does the conservatism principle dictate?

Answer 14

Choose the alternative that results in less net income or a smaller asset amount when there are two acceptable ways to record a transaction

This principle is used when doubt exists.

Question 15

What is meant by consistency and comparability in accounting?

Answer 15

Accounting principles must be applied consistently from period to period, and financial statements should be comparable across companies in the same industry

Changes must be disclosed if justified.

Question 16

Why is relevance and timeliness important for financial statements?

Answer 16

Financial statements should be distributed as soon as possible after the accounting period to enhance relevance

This often requires estimating some amounts.

Question 17

What is required for objectivity and reliability in accounting?

Answer 17

Accountants must be unbiased and financial statements may require auditing for assurance

This is to ensure the amounts reported are objective and reliable.

Question 18

What is included in a complete set of financial statements?

Answer 18

• Income statement
• Statement of comprehensive income
• Balance sheet
• Statement of stockholders’ equity
• Statement of cash flows
• Notes to the financial statements

Each component provides integral information about the company’s financial affairs.

Question 19

What does the accrual method of accounting require?

Answer 19

Revenues and expenses must be reported when they are earned or incurred, not when cash is received or paid

This method enhances the completeness of financial statements.

Question 20

Under the accrual method, when are revenues reported?

Answer 20

When they were earned

This can happen before, at the time of, or after receiving payment.

Question 21

How are expenses reported under the accrual method?

Answer 21

During the accounting period in which they were incurred

This includes expenses caused by revenues, expired expenses, and those with no future economic benefit.

Question 22

What does the cost principle state regarding asset reporting?

Answer 22

Assets are recorded at their cost at the time of the transaction and typically not adjusted for inflation or market value

This means a company’s land bought at $50,000 will still be reported at that cost, regardless of its current market value.

Question 23

What is the market value of the land mentioned?

Answer 23

$300,000

Question 24

At what value will the company report the land on its balance sheet?

Answer 24

$50,000

Question 25

How does a company report its inventory?

Answer 25

At its cost, not at the sales value

Question 26

What principle prevents a company from recording talented employees as assets?

Answer 26

The cost principle

Question 27

Can a company report internally developed brands and logos as assets?

Answer 27

No

Question 28

What must happen if an asset’s fair value drops below its book value?

Answer 28

The asset’s book value may have to be decreased and an impairment loss reported on the income statement

Question 29

What are liabilities?

Answer 29

A company’s obligations resulting from a past transaction

Question 30

List some typical liabilities reported on the balance sheet.

Answer 30

• Accounts payable
• Notes or loans payable
• Wages payable
• Interest payable
• Taxes payable
• Customer deposits
• Deferred revenue

Question 31

What are examples of amounts owed by a company at the end of each accounting period?

Answer 31

• Interest on loans payable
• Electricity and gas charges
• Wages for hourly paid employees that have been earned but not yet processed
• Repair work done by a contractor

Question 32

What method must be complied with for recording obligations and related expenses?

Answer 32

The accrual method of accounting

Question 33

What is stockholders’ equity?

Answer 33

The difference between a corporation’s assets and liabilities

Question 34

What is owner’s equity?

Answer 34

The difference between a sole proprietorship’s assets and liabilities

Question 35

Why might reported stockholders’ equity not indicate a corporation’s market value?

Answer 35

Most of a company’s assets are reported at cost or lower

Question 36

What does the full disclosure principle require?

Answer 36

Sufficient financial information must be presented for informed decision-making

Question 37

What are some items commonly disclosed in the notes to the financial statements?

Answer 37

• Summary of significant accounting policies
• Leases
• Income taxes
• Employee benefit plans
• Stock options
• Commitments and contingencies

Question 38

True or False: Financial statement reporting and income tax reporting are presented with the same complexities.

Answer 38

False

Question 39

Who should you consult for assistance with specific accounting and tax circumstances?

Answer 39

Accounting and tax professionals