Chapter 1 - 12 Basic Principles

Question 0

Accounting Entity

Answer 0

The business unit (regardless of the legal form) for which the financial statements are being prepared.

• This principle states that there is a “business entity” separate from its owner.

Question 1

What are the Twelve Basic Principles of Financial Statement Reports?

Answer 1

1. The Accounting Entity
2. going concern
3. Measurement
4. units of measure
5. historical cost
6. materiality
7. estimates and judgments
8. consistency
9. conservatism
10. periodicity
11. substance over form
12. accrual basis of presentation

Question 2

Going Concern

Answer 2

Unless there is evidence to the contrary, accountants assume that the life of the business entity is infinitely long.

This assumption does greatly simplify the presentation of the financial position of the firm and aids in the preparation of financial statements.

Question 3

Measurement

Answer 3

Accountants only deals with things that can be quantified.

I.e.: Loyal customers, while necessary for company success, still cannot be quantified and assigned a value and thus are not stated in the books.

Question 4

A Set of Financial Statements contains only measures of what…?

Answer 4

1. Assets : What the business owns
2. Liabilities: What the business owes
3. Owner’s Equity: The difference between the two
   Assets - Liabilities = Owner’s Equity

Question 5

Units of Measure

Answer 5

U.S Dollars are the units of value reported in the financial statements of US companies.

Question 6

Historical Cost

Answer 6

What a company owns and what it owes are recorded at their original (historical) cost with no adjustment for inflation.

Question 7

Materiality

Answer 7

Refers to the relative importance of financial information.
I.e.: Accountants don’t sweat the small stuff but all transactions must be reported if they would materially effect the financial company.

*Materiality is a straightforward judgement call.

Question 8

Estimates and Judgements

Answer 8

It is okay to guess if (1) that is the best you can do (2) the expected error would not matter much anyway.

*Use the same guessing method.

Question 9

Consistency

Answer 9

Sometimes identical transactions could be accounted for differently. Each individual enterprise must choose a single method of reporting and use it consistently from one fiscal year to another.

Question 10

Conservatism

Answer 10

Accountants prefer understatement to overvaluation.

I.e.:losses are recorded when you feel that they have a great probability of occurring while recording a gain is postponed until it actually occurs, not when it is only anticipated.

Question 11

Periodicity

Answer 11

The life of a corporation can be divided into periods of time for which profits and losses can be reported, usually a month, quarter or year.

Question 12

Substance Over Form

Answer 12

Report the economic “substance” of a transaction rather than just its form.

*If its a duck… then you must report it as a duck.”

Question 13

Accrual Basis

Answer 13

Dollars of profit or loss the money making (or losing) activities that take place in a fiscal period.

Question 14

Revenue Recognition

Answer 14

A sale is recorded when all the necessary activities to provide the good or service has been completed regardless when cash changes hands.

Question 15

Matching Principal

Answer 15

The costs associated with making products (Costs of Goods Sold) are recorded at the same time the matching revenue is recorded.

Question 16

Allocation

Answer 16

Many costs are not specifically associated with a product. These costs must be allocated to fiscal periods in a reasonable fashion.

Question 17

Who Makes the Rules and what are those rules called ?

Answer 17

Financial Accounting Standards Board

Generally Accepted Accounting Principals

Question 18

Explain what a “Single line” on a financial statement means.

Answer 18

It indicates that a calculation (addition or subtraction) has been made on the number just preceding in the column.

Question 19

Explain the meaning of “double underlines.”

Answer 19

It is saved for last. It signifies the very last figure in the statement.

Question 20

What type of businesses must use Accrual Basis of accounting?

Answer 20

All businesses with inventory must use the accrual basis of accounting.