Chapter 1

Question 1

What is Accounting?

Answer 1

Three activities - it identifies, records, and communicates the economic events of an organization to interested users.

Question 2

What does Bookkeeping regard?

Answer 2

Bookkeeping regards ONLY the RECORDING of economic events. (The recording part of accounting).

Question 3

What are the first users of financial information, INTERNAL USERS, generally concerned with?

Answer 3

The actual running or management of the business such as Finances (company cash flow to pay dividends), Marketing (product or service pricing to maximize net income), Human Resources (employee budgets/wages), Management (cutting or keeping product/services based on profitability).

Question 4

What does MANAGERIAL ACCOUNTING provide (for Internal Users)?

Answer 4

Managerial Accounting provides internal reports to help users make decisions about their companies (Financial comparisons, projections of income, forecasting future needs and expenses).

Question 5

Who are the second users of financial information, EXTERNAL USERS, and what are they generally concerned with?

Answer 5

External users of financial information are individuals or organizations outside a company that want financial information (Investors and Creditors).

Investors (owners) are concerned with decisions to buy, hold, or sell ownership shares of a company.

Creditors (suppliers and bankers) are concerned with evaluating the risk of granting credit or lending money (based on the financial information).

Question 6

What does FINANCIAL ACCOUNTING provide (for External Users)?

Answer 6

Financial Accounting provides economic and financial information for investors, creditors and other external users (such as whether they are abiding by tax laws, operating within prescribed rules and regulations, whether they’ll continue to honor product warranties or support their product lines or whether owners will be able to pay increased wages/benefits).

Question 7

What are ETHICS regarding Accounting?

Answer 7

Ethics are the standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or unfair. Financial reporting depends on ethics (honesty).

Question 8

Terminology: GAAP

Answer 8

Generally Accepted Accounting Principles:

Generally accepted and universally practiced standards in Accounting.

Question 9

Terminology: FASB

Answer 9

Financial Accounting Standards Board:

The primary accounting standard-setting body in the US.

Question 10

Terminology: SEC

Answer 10

Securities and Exchange Commission:
US Government Agency overseeing U.S. financial markets and accounting standard-setting bodies. (Relies on FASB to develop accounting standards, which public companies must follow).

Question 11

Terminology: IASB

Answer 11

International Accounting Standards Board:

Issues accounting standards for countries outside of the US called International Financial Reporting Standards (IFRS).

Question 12

What is CONVERGENCE in regard to Accounting and why is it important?

Answer 12

Convergence is efforts made by the two Standard-Setting bodies to increase comparability of financial reports internationally by reducing the differences between U.S. GAAP and Intl. IFRS (with hopes to someday eventually produce a single set of high-quality accounting standards to be used worldwide).

Question 13

GAAP uses what two principles?

Answer 13

GAAP uses the COST PRINCIPLE and the FAIR VALUE PRINCIPLE.

Question 14

Selection of which principle to follow leads to trade-offs between Relevance and Faithful Representation. RELEVANCE means?

Answer 14

Relevance means that the financial information is capable of making a difference in a decision.

Question 15

Selection of which principle to follow leads to trade-offs between Relevance and Faithful Representation. FAITHFUL REPRESENTATION means?

Answer 15

Faithful Representation means that the numbers and descriptions match what really happened – it is FACTUAL.

Question 16

Terminology: COST PRINCIPLE

Answer 16

The Cost Principle (or Historical Cost Principle) dictates that companies record assets at their cost (not only at the time of purchase but also over time as the asset is held.

Ex: If Company “X” buys land for $300,000, it initially reports it in it’s accounting record as $300,000. If by the end of the next year the fair value of the land rose to $400,000, then under the COST PRINCIPLE, Best Buy would continue to report the land at $300,000 (as originally purchased).

Question 17

Terminology: FAIR VALUE PRINCIPLE

Answer 17

The Fair Value Principle states that assets and liabilities should be reported at fair value (the received to sell an asset or settle a liability (relatively current price given?). Where most companies generally prefer the nature of cost figures (Cost Principle?), companies such as Investment firms prefer the RELEVANCE of Fair Value, because this information is readily available for such assets as securities (which are frequently and actively traded).

Question 18

ASSUMPTIONS provide a foundation for the Accounting Process. Two main assumptions are:

Answer 18

Two main assumption for the Accounting Process are the MONETARY UNIT ASSUMPTION and the ECONOMIC ENTITY ASSUMPTION.

Question 19

Terminology: MONETARY UNIT ASSUMPTION

Answer 19

The Monetary Unit Assumption requires that companies include in the accounting records only transaction data that can be expressed in money terms. This assumption enables accounting to QUANTIFY (measure) economic events and is VITAL TO APPLYING the COST PRINCIPLE.

Ex. Basically company cannot record or include quality of service, health of owner, morale of employees because it cannot be quantified by money (although still important.)

Question 20

Terminology: ECONOMIC ENTITY ASSUMPTION

Answer 20

The Economic Entity Assumption requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.

Ex: Pedro, owner of Hot Tamales, must keep his personal living costs separate from the expenses of his business, Hot Tamales. Similarly, Taco Bell, Hot Tamales and Coca-Cola are segregated into separate ECONOMIC ENTITIES for Accounting purposes.

Question 21

What are some examples of an Economic Entity?

Answer 21

An ECONOMIC ENTITY may be a COMPANY (such as Crocs. Inc), a GOVERNMENTAL UNIT (the STATE of WASHINGTON), a MUNICIPALITY (the city of Yakima or Seattle), a SCHOOL DISTRICT (Pasco School District #XX), or a CHURCH (the LDS or Catholic Church).

Question 22

Terminology: PROPRIETORSHIP

Answer 22

A Proprietorship is a business owned by one person. The owner is often a manager/operator of the business (such as plumbing companies, beauty salons, auto-repair shops, farms, clothing stores) usually only needing a small amount of money to start the business up. The owner (proprietor) receives any profits, suffers any losses, and is personally liable for all debts of the business. ECONOMIC ASSUMPTION must be employed in a Proprietorship.

Question 23

Terminology: PARTNERSHIP

Answer 23

A Partnership is a business owned by two or more persons associated as partners. It’s similar to a proprietorship except that more than one owner is involved, typically with an agreement (written or oral) that sets forth such term as initial investments, individual duties, division of net income (or net loss), and settlement to be made upon death or withdrawal. Each partner generally has unlimited personal liability for the debts of the partnership. ECONOMIC ENTITY ASSUMPTION must also be used with Partnerships. Examples of partnerships: organized retail and service-type businesses, including professional practices (lawyers, doctors, architects, and CPA’s)

Question 24

Terminology: CORPORATION

Answer 24

A Corporation is a business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock. The holders of the shares (stockholders) enjoy limited liability; they are not personally liable for the debts of the corporate entity. Stock holders may transfer all or part of their ownership shares to other investors at any time (i.e., sell their shares). Attractive for it’s ease in change of ownership (without dissolving it), the corporation can enjoy an unlimited life.

Question 25

Terminology: ASSETS

Answer 25

Assets are the resources a business owns. The business uses its assets in carrying out such activities as production and sales with a common characteristic being the capacity to provide future services or benefits. In a business, that service potential or economic benefit eventually results in cash inflows (receipts).

Examples of Assets: Tables, chairs, jukebox, cash register, oven, tableware, and of course cash owned by a Pizza joint.

Question 26

Terminology: LIABILITIES

Answer 26

Liabilities are claims against ASSETS, meaning existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit. When the business or entity owes money to its creditors, the creditors may legally force liquidation of a business that does not pay its debts which in turn may require creditor claims be paid before ownership claims (by law).

Question 27

Liabilities: What are some Liability claims? (these are based on borrowed money from creditors)

Answer 27

ACCOUNTS PAYABLE: (Food ingredients purchased on credit from a supplier for a Pizza joint.)

NOTE PAYABLE: (Has a Note Payable to a bank for money borrowed to purchase a delivery truck.)

SALARIES AND WAGES PAYABLE: (To employees.)

SALES AND REAL ESTATE TAXES PAYABLE: (To local Government)

Question 28

Terminology: OWNER’S EQUITY

Answer 28

Owner’s Equity is the ownership claim on total ASSETS. It is total assets minus total liabilities. Why?: Since the Assets of a business are claimed by either creditors or owners and also, since by law, creditors claims must be paid first, the remained is the Owner’s Equity, also known as RESIDUAL EQUITY.