FA 1 - The Accounting Equation

Question 1

The accounting equation is

Answer 1

Assets = Liabilities + Owners’ Equity
Assets are the resources that the business has, and liabilities + owners’ equity are the means by which the business obtained those resources.

Question 2

What is a transaction?

Answer 2

A transaction is an event that occours during the course of business

Question 3

What is the accrual method of accounting?

Answer 3

The accrual method of accounting ensures that transactions are recorded in the period to which they relate, regardless of when cash is exchanged.

Question 4

Assets

Answer 4

Assets are resources owned or controlled by an entity that will produce benefits in the future.

Question 5

Liabilities

Answer 5

Liabilities are obligations to pay a third party for resources provided to an entity.

Question 6

Owners’ equity

Answer 6

Owners’ equity consists of funds contributed by owners as well as profits generated by the business.
Owners’ equity = Assets - Liabilities

Question 7

Revenue

Answer 7

Revenue is the money that a business receives from providing goods or services to a customer.

Question 8

Expenses

Answer 8

Expenses are the costs associated with providing goods and services to a customer.

Question 9

The Matching Principle

Answer 9

A company’s must match its expenses to the rebated revenues in the accounting period to which they relate.

Question 10

How do you record a sale?

Answer 10

Revenue - cash up (A), revenue up (OE)

Inventory - Inventory down (A), inventory down (OE)

Question 11

How do you record a credit purchase?

Answer 11

When received - Inventory up (A), obligation to pay up (L)

When paid - cash down (A), obligation to pay down (L)

Question 12

What is an accounting period?

Answer 12

The time period for which results are being reported

Question 13

Realization Principle

Answer 13

If the business has done the work and can expect to receive cash, it can recognize the revenue even if it hasn’t received the cash yet.

Question 14

Under the accrual method, when is revenue recognized?

Answer 14

When merchandise is delivered

Question 15

How do you record a credit sale?

Answer 15

Time of sale - cash receivable up (A), revenue up (OE)
Time of sale - inventory down (A), inventory down (OE)
Cash received - cash up (A), cash receivable down (A)

Question 16

How do you record advance payments?

Answer 16

Time of payment - cash up (A), obligation for goods and services up (L)
Every month - obligation down (L), revenue up (OE)

Question 17

How do you record making pre-payments?

Answer 17

Time of payment - cash down (A), goods/service receivable up (A)
Every month - goods/service receivable down (A), expense down (OE)

Question 18

Conservatism

Answer 18

Practice of recording anticipated liabilities but not future gains
Objective - to prevent overly optimistic financial reports.

Question 19

What are the guidelines for financial reporting?

Answer 19

Relevance - useful, capable of influencing the decisions of users of the financial statement; and
Reliability - information faithfully represents the underlying economics and transactions.
The three dimensions of reliability - information is valid, verifiable, unbiased.

Question 20

Historical Cost Principle

Answer 20

Transactions are recorded at the actual price that existed at the time of the transaction.
Objective - to curtail the risk of overstated assets in financial statements; but the downside is that information might be out of date and the knowledge of that opens it up to inflated speculation.

Question 21

Consistency

Answer 21

Practice of managers making consistent accounting choices over time, since accounting often requires judgment and choice.

Question 22

Materiality Principle

Answer 22

Trivial transactions don’t have to be reported in detail.
A transaction is considered material if it is reasonably likely to impact the decision-making of the users of the financial report.
Materiality varies from business to business

Question 23

Entity Concept

Answer 23

A business is a separately identifiable entity.

i.e. only transactions relating to the business should be recorded in financial reports.

Question 24

Money Measurement

Answer 24

Only values that can be recorded in monetary terms get recorded in financial statements.
Closely tied to the principles of reliability and historical cost.

Question 25

Going Concern

Answer 25

The assumption that the business will continue to operate in the foreseeable future - i.e. assets will continue to be used, liabilities will continue to be settled.

Question 26

What are the standards for something to be considered an asset?

Answer 26

• Purchased at a measurable cost;
• Produces economic benefit in the future;
• Results from a past event; and
• Is owned or controlled by the entity.

Question 27

What are the criteria for something to be a liability?

Answer 27

• Impose probable economic obligation on economic resources in the future;
• Obligation has to be to another entity; and
• The event that created the obligation must have occoured in the past.

Question 28

What are the transactions that affect equity?

Answer 28

Revenues and expenses;
Gains and losses;
Contributions by owners; and
Company makes a distribution to owners.