CH.7 Accounting Principles

Question 1

Explain generally accepted accounting principles (GAAP)

Answer 1

GAAP are a set of standards and rules that are recognized as a general guide for financial reporting purposes. These principles must have “substantial authoritative support.”

Question 2

Identify the key items of the conceptual framework

Answer 2

A. Objectives of financial reporting.

B. Qualitative characteristics of accounting information.

C. Elements of financial statements.

D. Operating guidelines (assumptions, principles, and constraints).

Question 3

Describe the basic objectives of financial reporting

Answer 3

The objectives of financial reporting are to provide information that is useful in (a) making investments and credit decisions; (b) assessing future cash flows; and (c) identifying the economic resources (assets), the claims to those resources (liabilities), and the changes in those resources and claims.

Question 4

Discuss the qualitative characteristics of accounting information

Answer 4

A. RELEVANCE. The information must be capable of making a difference in a decision. Relevant information has either predictive or feedback value; and is also timely.

B. RELIABILITY. The information should be free of error and bias and be dependable.

C. COMPARABILITY. The information should be comparable with accounting information about other enterprises.

D. CONSISTENCY. The same accounting principles and methods should be used from year to year within a company.

Question 5

Discuss the elements of financial statements

Answer 5

Elements of financial statements are a set of definitions of the basic terms used in accounting. These elements include such terms as assets, liabilities, equity, revenues, and expenses.

Question 6

Explain operating guidelines

Answer 6

Operating guidelines used by accountants to solve practical problems include assumptions, principles, and constraints.

Question 7

Identify the basic assumptions used by accountants

Answer 7

A. Monetary unit assumption - states that only transaction data capable of being expressed in terms of money should be included in the accounting records of the economic entity. An important corollary is the added assumption that the unit of measure remains sufficiently constant over time.

B. Economic entity assumption - states that economic events can be identified with a particular unit of accountability.

C. Time period assumption - states that the economic life of a business can be divided into artificial time periods.

D. Going concern assumption - states that the enterprise will continue in operation long enough to carry out its existing objectives.

Question 8

Identify the basic principles of accounting

Answer 8

1. Revenue recognition principles - dictates that revenue should be recognized in the accounting period in which it is earned. When a sale is involved, revenue is recognized at the point of sale.
2. Matching principle - requires that expenses be matched with revenues in the period in which efforts are expended to generate revenues. Expenses are not recognized when cash is paid, or the work performed; they are recognized when the labor (services) or product actually makes its contributions to revenue.
3. Full disclosure principle - requires that circumstances and events that make a difference to financial statement users be disclosed. Compliance with this principle occurs through the data contained in the financial statements and the information in the notes that accompany the statements.
4. Cost principle:
   a. Cost is relevant because it represents the price paid, the assets sacrificed, or the commitment made at the date of acquisition.
   b. Cost is reliable because it is objectively measurable, factual and verifiable.

Question 9

Identify the two constraints in accounting

Answer 9

1. Materiality means that an item is likely to influence the decision of a reasonably prudent investor.
2. Conservatism means that when in doubt choose the method that will be least likely to overstate assets and income.