Chapter 1: Accounting in Action

Question 1

Explain the Going Concern Assumption.

Answer 1

Assumes that a business will continue to operate into the foreseeable future and the business’s assets are required for the continued operation. Because the assets are required for operation, they are not for sale. Therefore, their current market value is irrelevant.

Question 2

Explain the Economic Entity Assumption (AKA Reporting Entity).

Answer 2

Business expenses must be separate from personal expenses.

Question 3

Explain the Monetary Unit Assumption.

Answer 3

Only events results in transactions that can be expressed as money will be recorded. Such events are recorded in the currency of the business entity’s country.

Question 4

Explain the Historical Cost Principle

Answer 4

Economic or business transactions are always recorded using the actual cost of the consideration transferred between the parties. Assets must always be recorded at their historical (original) cost regardless of current perceived fair market value.

Question 5

Explain the Realization (Revenue Recognition) Principle

Answer 5

Revenue should be recorded (recognized) in the accounting records in the period in which it is earned, not when the cash is received.

Costs should be recorded (recognized) in the accounting records in the period in which they are incurred, not when the cash is paid.

Question 6

Explain the Matching Principle.

Answer 6

Whenever possible, the costs incurred to generate revenue should be matched and recorded at the same time as the related revenue.

Question 7

Explain the Periodicity Concept (AKA Time Period)

Answer 7

For accounting information to be relevant, users require it on a timely basis. Guides organizations in dividing up their economic activities into distinct time period. The most common time periods are months, quarters, and years.

Question 8

What is the basic accounting equation?

Answer 8

Assets = Liabilities + Owner Equity

Question 9

What is an asset and provide three examples of assets?

Answer 9

A resources which will benefit (assist in earning income) both the current period as well as future periods.
Examples: Cash, Accounts Receivable, Supplies, Inventory for resale, Land, Buildings, Equipment, Vehicles

Question 10

What is a liability and provide 2 examples of liabilities?

Answer 10

Debts or obligations incurred as expenses or to purchase assets.
Examples: Notes Payable, Accounts Payable

Question 11

What is Owner Equity?

Answer 11

Represents the owner’s ownership of assets (the difference between assets and liabilities). Includes Owners Capital and Owner’s Drawings.

Question 12

Explain Revenue?

Answer 12

Revenue is money earned as a result of either services being provided or products being sold.

Question 13

Explain expenses?

Answer 13

Expenses are costs incurred in order to generate revenue.

Question 14

Explain Personal Withdrawals

Answer 14

When the owner of a business takes resources out of the business for their own personal use, this is NOT an expense of the business, as it is not used to generate business revenue. This is called an Owner Withdrawal.

Question 15

What are the four financial statements and what order are they prepared in?

Answer 15

1. Income Statement
2. Statement of Owner’s Equity
3. Balance Sheet
4. Statement of Cash Flow

Question 16

What is the income statement?

Answer 16

The main purpose of the income statement is to report the profitability of the business’ operations over a specified period of time. Profit is measured by the difference between revenue and expenses.

Question 17

What is the Statement of Changes in Owners Equity?

Answer 17

Summarizes all transactions that will affect owner’s equity for the entire accounting period. Investments and profit increase owner’s equity. Owner withdrawals decrease it.

Question 18

What is the Balance Sheet?

Answer 18

The balance sheet summarizes assets, liabilities, and owner’s equity. It is a snapshot of the resources (assets) and obligations (liabilities or debts) of the business, as well as the owner’s ownership of those resources at a particular point in time.

Question 19

What is the statement of cash flow?

Answer 19

The cash flow statement gives information about the cash receipts and cash payments for a specific period of time.

Question 20

What are the three types of Business Organization?

Answer 20

Proprietorship, Partnership, and Corporation.

Question 21

Describe a Proprietorship and include the terminology for the balance sheet.

Answer 21

1 Owner, Limited life of business, owners are personally liable. Balance sheet terms are Owner’s Equity and Owner Capital.

Question 22

Describe a Partnership and include the terms for the balance sheet.

Answer 22

2 or more partners, limited life of a business, partners are personally liable. Balance sheet terms are Partners’ Equity and Partners’ Capital.

Question 23

Describe a Corporation and include terms for the balance sheet.

Answer 23

Many owners - called shareholders. Unlimited life of business, shareholders are NOT personally liable. Balance sheet terms of Shareholders’ Equity, Common Shares, and Retained Earnings.

Question 24

Using the expanded accounting equation, what is the equation for owner’s equity?

Answer 24

Owners Capital (investements) - Drawings + Profit (or - Loss). Profit = Revenue - Expenses