Chapter 2

Question 1

The fundamental qualities of accounting information are:

Answer 1

Relevance:

• Predictive value
• Confirmatory value
• Materiality

Faithful representation:

• Completeness
• Neutrality
• Free from error

Question 2

Enhancing qualities complement the fundamental qualities and include:

Answer 2

Comparability
Verifiability
Timeliness
Understandability

Question 3

Assets

Answer 3

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Question 4

Liabilities

Answer 4

Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Question 5

Equity

Answer 5

Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest.

Question 6

Investments by Owners

Answer 6

Increases in net assets of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it. Assets are most commonly received as investments by owners, but that which is received may include services or satisfaction or conversion of liabilities of the enterprise.

Question 7

Distributions to Owners

Answer 7

Decreases in net assets of a particular enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interests (or equity) in an enterprise.

Question 8

Comprehensive Income

Answer 8

Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Question 9

Revenues

Answer 9

Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.

Question 10

Expenses

Answer 10

Outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.

Question 11

Gains

Answer 11

Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners.

Question 12

Losses

Answer 12

Decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners.

Question 13

Basic Assumptions

Answer 13

In the practice of financial accounting, certain basic assumptions are important to an understanding of the manner in which data are presented. The following four basic assumptions underlie the financial accounting structure

Question 14

Basic Principles

Answer 14

Certain basic principles are followed by accountants in recording and reporting the transactions of a business entity. These principles relate to how assets, liabilities, revenues, and expenses are to be identified, measured, and reported.

Question 15

Economic Entity Assumption

Answer 15

Economic activity can be identified with a particular unit of accountability in a manner that assumes the company is separate and distinct from its owners or other business units.

Question 16

Going Concern Assumption

Answer 16

In the absence of contrary information, a company is assumed to have a long life. The current relevance of the historical cost principle is dependent on the going-concern assumption.

Question 17

Monetary Unit Assumption

Answer 17

Money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. The monetary unit is assumed to remain relatively stable over the years in terms of purchasing power. In essence, this assumption disregards any inflation or deflation in the economy in which the company operates.

Question 18

Periodicity Assumption

Answer 18

The economic activities of a company can be divided into artificial time periods for the purpose of providing the company’s periodic reports.

Question 19

Measurement Principle

Answer 19

A ‘mixed-attribute’ system permits the use of various measurement bases.

Question 20

Historical Cost Principle

Answer 20

Acquisition cost is considered a reliable basis upon which to account for assets and liabilities of a company. Historical cost has an advantage over other valuations, as it is thought to be verifiable.

Question 21

Fair Value Principle

Answer 21

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in on orderly transaction between market participants at the measurement date. Recently, GAAP has increasingly called for the use of fair value measurements in the financial statements.

Question 22

Revenue Recognition Principle

Answer 22

Revenue is recognized at the time in which the performance obligation is satisfied.

Question 23

Expense Recognition Principle (matching principle)

Answer 23

Recognition of expenses is related to net changes in assets and earning revenues. The expense recognition principle is implemented in accordance with the definition of expense by matching efforts (expenses) with accomplishment (revenues).

Question 24

Product costs

Answer 24

such as material, labor, and overhead, attach to the product, and are recognized in the same period the products are sold.

Question 25

Period costs

Answer 25

such as officers’ salaries and other administrative expenses, attach to the period, and are recognized in the period incurred.

Question 26

Full Disclosure Principle

Answer 26

In the preparation of financial statements, the accountant should include sufficient information to influence the judgment and decision of an informed user. A series of judgmental tradeoffs must occur.

Question 27

Cost Constraint

Answer 27

The cost constraint (or cost-benefit relationship) relates to the notion that the benefits to be derived from providing certain accounting information should exceed the costs of providing that information. The difficulty in cost-benefit analysis is that the costs and especially the benefits are not always evident or measurable.