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					         Chapter 014 Accounting Principles and Reporting Standards


True / False Questions


1. The Financial Accounting Standards Board is an agency of the federal government.
True False



2. Because financial statements must be objective and based on verifiable evidence, data
obtained from estimates cannot be presented.
True False



3. The concepts of objectivity and verifiability eliminate subjective decisions.
True False



4. Most businesses follow the general rule that revenue is recognized when cash is received.
True False



5. The concept of realization permits a company to recognize income whenever there is an
increase in the market value of the assets it holds.
True False



6. The separate entity assumption permits businesses to record property and equipment as
assets that will provide benefits in future periods.
True False



7. For convenience, accountants assume that the value of money is stable or that changes in its
value are not great enough to affect the recorded financial data.
True False




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         Chapter 014 Accounting Principles and Reporting Standards



8. If an expenditure that is expected to benefit future periods is made during one accounting
period, the cost should be divided and charged as an expense during each period benefited.
True False



9. Assets are recorded at cost when they are purchased, but the asset accounts are adjusted
each year to reflect changes in market value.
True False



10. The matching principle requires that all known costs be charged to the current period of
operations.
True False



11. Assets are carried on the books at historical cost until they are used.
True False



12. The matching principle is being applied when the cost of equipment is depreciated over its
useful life.
True False



13. Accountants use footnotes to financial statements to disclose information that may
influence investor decisions.
True False



14. If too much of the cost of an asset is charged as depreciation expense in the present
period, the firm's net income will be understated in later periods.
True False




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         Chapter 014 Accounting Principles and Reporting Standards



15. A firm is following generally accepted accounting principles if it reports merchandise
inventory on the balance sheet at its expected selling price rather than at its cost.
True False




Fill in the Blank Questions


16. The SEC has authority to define accounting terms and to prescribe accounting procedures
used by all ____________________ held corporations.
________________________________________



17. Financial accounting rules affect the recording of data used to prepare financial reports
that go to ____________________ and creditors.
________________________________________



18. Financial information is said to be ____________________ if it can be reviewed by
accountants outside the company, and these accountants arrive at the same conclusions as the
preparers of the firm's financial statements.
________________________________________



19. Revenue should not be recorded until it is ____________________; that is, until new
assets are created in the form of money or claims against others.
________________________________________



20. The ____________________ assumption permits the costs of assets purchased many
years ago to be added to the costs of newly purchased assets for financial statement reporting.
________________________________________




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         Chapter 014 Accounting Principles and Reporting Standards



21. The ____________________ assumption permits carrying forward a portion of the cost of
assets that will be used in future periods.
________________________________________



22. An accountant generally assumes that a firm is a(n) ____________________ concern and
will continue to operate indefinitely.
________________________________________



23. If an important fact that would have an effect on an investor's decisions is omitted from
the financial statements, the ____________________ principle has been violated.
________________________________________



24. The accountant records an expense for wages earned by employees during the last four
days of the year, even though the wages will not be paid in that year. The accountant is
following the ____________________ principle.
________________________________________



25. The ____________________ principle requires that if income is to be properly measured,
all expired costs associated with the earning of revenue must be deducted from the revenue.
________________________________________



26. If the ____________________ basis of accounting is used, income is recorded in the
period in which it is earned.
________________________________________



27. The ____________________ basis of accounting means that business transactions are
recorded based on an "arm's length" transaction in the market.
________________________________________




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         Chapter 014 Accounting Principles and Reporting Standards



28. The modifying convention of ____________________ concerns the significance of an
item in relation to the particular situation of which it is a part.
________________________________________



29. Because of the modifying convention of ____________________, assets are understated
rather than overstated if any question exists.
________________________________________



30. Lack of ____________________ would result in financial reports that are not comparable
with earlier statements.
________________________________________




Multiple Choice Questions


31. In order to ensure that they are meaningful and useful, financial statements should be
prepared
A. in accordance with section 108 of the Sarbanes-Oxley Act.
B. on a daily basis.
C. on a timely basis.
D. using generally accepting accounting principles (GAAP).



32. Which of the following statements is not correct?
A. The Securities and Exchange Commission (SEC) issues the Statements of Financial
Accounting Standards.
B. Statements issued by the Financial Accounting Standards Board (FASB) are binding on the
members of the American Institute of Certified Public Accountants (AICPA).
C. An act of law gave the SEC the authority to determine the form and content of accounting
reports filed by companies under its jurisdiction.
D. All of these statements are correct.




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         Chapter 014 Accounting Principles and Reporting Standards



33. The Statements of Financial Accounting Standards that automatically become generally
accepted accounting principles are issued by
A. the IRS.
B. the SEC.
C. the FASB.
D. the AICPA.



34. The Financial Accounting Standards Board is
A. a branch of the AICPA.
B. a branch of the IRS.
C. an independent organization.
D. a branch of the SEC.



35. The Accounting Standards Executive Committee issues three important types of
documents
A. accounting and auditing guides.
B. statements of position.
C. practice bulletins.
D. all of these.



36. In its conceptual framework, the FASB concluded that financial reporting rules should
concentrate on providing information that is helpful to
A. current and potential investors and creditors in making investment and credit decisions.
B. management, tax authorities, and regulatory agencies.
C. Both of the above.
D. Neither of the above.



37. Investors and creditors expect to receive a cash flow from the business entity
A. directly from the distribution of the company's earnings.
B. indirectly through the disposition of their interests for cash.
C. Both of the above.
D. Neither of the above.




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         Chapter 014 Accounting Principles and Reporting Standards



38. Financial report users need information about
A. profits.
B. economic resources (assets).
C. claims against the assets (liabilities and owner's equity).
D. all of these.



39. The SEC's 2003 report to the Congress on "principles-based" accounting observed that the
first characteristic of objectives-based standards, dictated by the Sarbanes-Oxley Act, is that
any standard must be based on
A. the cost-benefit test.
B. an improved and consistently applied framework.
C. qualitative characteristics.
D. transparency.



40. Accounting information that is capable of making a difference in a decision by the report
user is
A. comparable.
B. reliable.
C. relevant.
D. neutral.



41. The Cervantes Company uses the same method of depreciation for its equipment in each
fiscal period. This practice is an example of
A. conservatism.
B. consistency.
C. materiality.
D. matching.




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         Chapter 014 Accounting Principles and Reporting Standards



42. The four assumptions financial statement users should be able to assume that preparers of
the statements have made in preparing the statements that are listed by the FASB's conceptual
framework are
A. separate economic entity, going concern, monetary unit, and periodicity of income.
B. conservatism, matching principle, revenue recognition principle, and periodicity of income.
C. conservatism, cost-benefit test, full disclosure principal, and industry practice constraint.
D. historical cost basis, materiality realization, and transparency.



43. Which of the following statements is correct?
A. Under the accrual basis of accounting, revenue is recorded in the period in which it is
earned.
B. Under the accrual basis of accounting, expenses are recorded in the period in which they
are incurred.
C. Both of the above statements are correct.
D. Neither of the above statements is correct.



44. Each year there was an increase in the market value of some stock owned by the
Mudstream Company, but the accountant did not record the increase in asset value and equity
until the stock was sold. In this situation, the accountant
A. followed the matching principle.
B. followed the realization principle.
C. violated the accrual principle.
D. violated the matching principle.



45. Keeping the personal assets of the owner of a business separate from the assets of the firm
is an example of
A. following the going concern assumption.
B. applying the realization principle.
C. following the separate entity assumption.
D. applying the conservatism convention.




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         Chapter 014 Accounting Principles and Reporting Standards



46. When Tamar Snyder opened a shoe store, her accountant did not include the cash in her
personal savings account as one of the assets of the business. This is an example of
A. the separate entity assumption.
B. the conservatism principle.
C. the materiality principle.
D. industry practice principle.



47. Which of the following is allowed under generally accepted accounting principles?
A. A company was offered $60,000 for land that it had purchased for $15,000. The company
did not sell the land but increased the Land account to $60,000.
B. An owner lists the full cost of his or her personal automobile, which is occasionally used
for business purposes, on the company's balance sheet.
C. A large company recorded the $20 cost of a tool as an expense, although the item is
expected to be used for 3 years.
D. The Equipment account shows a balance of $55,000. This amount represents the original
cost of $75,000 less the accumulated depreciation of $20,000.



48. Recording land at its cost rather than its appraisal value illustrates
A. the full disclosure principle.
B. the cost basis principle.
C. the realization principle.
D. the matching principle.



49. An accountant who records revenue when a credit sale is made rather than waiting for the
receipt of cash from the customer is
A. following the accrual principle.
B. following the conservatism convention.
C. violating generally accepted accounting principles.
D. following the consistency principle.




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         Chapter 014 Accounting Principles and Reporting Standards



50. Depreciating equipment over its useful life is an example of
A. following the objectivity assumption.
B. applying the matching principle.
C. applying the realization principle.
D. applying the conservatism convention.



51. The financial statements in the annual report of a corporation contain footnotes explaining
the methods used to depreciate the firm's equipment. This practice is an example of
A. the consistency principle.
B. the conservatism principle.
C. the full disclosure principle.
D. the accrual principle.



52. The Garrison Company offers terms of net 30 days for its credit sales. It records the
revenue from these sales as soon as the sales are made rather than waiting until cash is
received from the customers. This is an example of the
A. realization principle.
B. matching principle.
C. conservatism principle.
D. consistency principle.



53. A deviation from generally accepted accounting principles is
A. permissible if the amount involved is material.
B. permissible if the amount involved is immaterial.
C. never allowed.
D. permissible only if its required in order to conform to the monetary unit assumption.



54. An accountant charged the Repairs Expense account for a tool that cost $12. The tool had
an estimated useful life of 5 years; however, the accountant did not choose to depreciate it.
The modifying convention that the accountant followed was
A. materiality.
B. objectivity.
C. conservatism.
D. industry practice.




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         Chapter 014 Accounting Principles and Reporting Standards



55. When a new company was formed, one partner contributed some used equipment he
owned. The equipment was appraised at $44,000 and $50,000 by two different dealers. The
accountant entered the equipment at $44,000 in the financial records of the partnership. This
is an example of
A. the materiality principle.
B. the conservatism principle.
C. the matching principle.
D. industry practice principle.




Essay Questions


56. What is meant by the concept of neutrality in accounting?




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         Chapter 014 Accounting Principles and Reporting Standards



57. Match the qualitative characteristics of accounting information with the descriptions by
entering the proper letter in the space provided.

A. Comparability
B. Consistency
C. Feedback value
D. Neutrality
E. Predictive value
F. Relevance
G. Reliability
H. Representational faithfulness
I. Timeliness
J. Verifiability
___ 1. Information that helps the statement user confirm fulfillment or no fulfillment of prior
expectations or decisions is said to have this qualitative characteristic.
___ 2. This qualitative characteristic means simply that the information should be dependable;
such information is verifiable, is a faithful representation of the company's financial affairs,
and is reasonably free of error and bias.
___ 3. This qualitative characteristic means that accounting information is capable of making
a difference in a decision by the report user.
___ 4. If an entity uses the same accounting treatment for similar events and data from period
to period, this qualitative characteristic is being met.
___ 5. If information is relevant, it will have this qualitative characteristic and enable
statement users in making predictions about the meaning and ultimate outcome of events
giving rise to the information.
___ 6. This qualitative characteristic is indicated when independent measurers obtain similar
results.
___ 7. Information that is presented soon enough after events are reported to be useful in
decision making would meet this qualitative characteristic.
___ 8. This is the concept that data shown in the financial reports reflect what really
happened.
___ 9. Often referred to as objectivity; it is the idea that the financial statements are not
prepared in a way to favor one group of users (management, owners, creditors, employees,
etc.) over other groups.
___ 10. When the financial data is presented in such a manner that it can be meaningfully
compared with the same data for other companies, it meets this qualitative characteristic.




                                             14-12
         Chapter 014 Accounting Principles and Reporting Standards



58. In recent years, it has been reported that several large companies have manipulated
business transactions and accounting records to change the net income reported on their
income statements. Suggest five concepts, assumptions, principles, or conventions that such
manipulation would violate.




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         Chapter 014 Accounting Principles and Reporting Standards

59. The income statement shown below was prepared and sent by Jenna Preston, the owner
of Preston Gifts, to several of her creditors. The business is a sole proprietorship that sells
miscellaneous gifts. An accountant for one of the creditors looked over the income statement
and found that it did not conform to generally accepted accounting principles. Using the
following additional information provided by the owner, prepare an income statement in
accordance with generally accepted accounting principles.




 Additional information provided by owner:
 1. All sales were for cash.
 2. The beginning and ending merchandise inventories were valued at their estimated selling
price. The actual cost of the ending inventory is estimated to be $12,000. The actual cost of
the beginning inventory is estimated to be $20,000.
 3. On December 31, 2011, suppliers of merchandise are owed $11,000. On January 1, 2012,
they were owed $14,000.
 4. The owner paid herself a salary of $1,250 per month and charged this amount to the Salary
of Owner account.
 5. A check for $800 to cover the December rent on the owner's personal apartment was
issued from the firm's bank account. This amount was charged to Rent Expense.




                                             14-14
Chapter 014 Accounting Principles and Reporting Standards




                          14-15
         Chapter 014 Accounting Principles and Reporting Standards

60. The income statement shown below was prepared and sent by Curtis Brown, the owner of
Curt's Crafts, to several of his creditors. The business is a sole proprietorship that sells crafts
and toys. An accountant for one of the creditors looked over the income statement and found
that it did not conform to generally accepted accounting principles. Using the following
additional information provided by the owner, prepare an income statement in accordance
with generally accepted accounting principles.




 Additional information provided by owner:
 1. On December 31, 2011, accounts receivable from customers total $32,000. On January 1,
2012, accounts receivable totaled $52,000.
 2. The beginning and ending merchandise inventories were valued at their estimated selling
price. The actual cost of the ending inventory is estimated to be $6,000. The actual cost of the
beginning inventory is estimated to be $18,000.
 3. On December 31, 2011 suppliers of merchandise are owed $16,000. On January 1, 2012,
they were owed $11,000.
 4. The owner paid himself a salary of $1,600 per month and charged this amount to the
Salaries Expense account.
 5. A check for $300 to cover the December electric bill on the owner's personal home was
issued from the firm's bank account. This amount was charged to Utilities Expense.




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Chapter 014 Accounting Principles and Reporting Standards




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         Chapter 014 Accounting Principles and Reporting Standards

61. Carlos Verde owns a small nursery. He recently approached the local bank for a loan to
finance an expansion of his nursery. Carlos prepared the balance sheet given below and
submitted it with his loan application. The balance sheet does not conform to generally
accepted accounting principles. Using the additional information provided by the owner,
prepare a corrected balance sheet in accordance with generally accepted accounting
principles.




 Additional information provided by owner:
 1. The inventory has an original cost of $42,000. It is listed on the balance sheet at what it
would cost to purchase today.
 2. Included in the cash listed on the balance sheet is $4,000 in Carlos Verde's personal
checking account.
 3. Depreciation allowable to date on the equipment is $5,000. Depreciation allowable to date
on the truck is $3,000.




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         Chapter 014 Accounting Principles and Reporting Standards

62. Antonio Hanley owns a small automobile service center. He recently approached the
local bank for a loan to finance an expansion of his service center. Antonio prepared the
balance sheet given below and submitted it with his loan application. The balance sheet does
not conform to generally accepted accounting principles. Using the additional information
provided by the owner, prepare a corrected balance sheet in accordance with generally
accepted accounting principles.




 Additional information provided by owner:
 1. The inventory has an original cost of $84,000. It is listed on the balance sheet at what it
would cost to purchase today.
 2. Included in the cash listed on the balance sheet is $8,000 in Antonio Hanley's personal
checking account.
 3. Depreciation allowable to date on the equipment is $10,000. Depreciation allowable to
date on the truck is $6,000.




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         Chapter 014 Accounting Principles and Reporting Standards



63. Indicate in each case whether the item has been handled in accordance with generally
accepted accounting principles (GAAP). If so, indicate the key basic concept that has been
followed. If not, indicate which concept has been violated and tell how the item should have
been recorded or presented.

 1. A piece of machinery has a book value (cost less accumulated depreciation) of $90,000.
However, the machinery could not be sold for more than $70,000 today. The company's
owner thinks that the machinery should nevertheless be reported on the balance sheet at
$90,000 and depreciated over its useful life, because the equipment is being used regularly in
the business and it is expected to be used for the next five years—the remaining useful life
that is being used for depreciation purposes.
 2. At the beginning of the year, the company bought a building for $1,000,000. At the end of
the year, the building's value was appraised at $1,220,000. Since there was an increase in
value, the company did not record depreciation on the building.
 3. The assets listed in the accounting records of the company, which is operated as a sole
proprietorship, include a savings account of the owner of the business. The owner established
the savings account so that if she needs to invest more cash in the business, it will be readily
available.
 4. Three years ago, the company paid for a three-year insurance policy on its automobiles by
writing a check for $6,000. At the end of the current year, the balance sheet of the company
reported prepaid insurance at $6,000.




                                             14-20
         Chapter 014 Accounting Principles and Reporting Standards



64. For each of the unrelated situations below, identify the accounting principle or concept
violated (if a violation exists) and explain the nature of the violation. If you believe that the
treatment is in accordance with GAAP, state the major principle or concept in support.

 1. White Farm Equipment Company manufactures tractors and combines. It pays its
salespeople a commission of 15 percent of the sales price as their remuneration. During the
current year, the company's sales were $100,000,000 and commissions amounted to
$15,000,000. In the income statement, sales are shown as $100,000,000.
 2. Plato Plastics Molding uses a large quantity of small tools in its manufacturing process.
The annual purchases of the tools, which have a life of about two years, are approximately 1
percent of the company's net income for the year. The company has followed the practice of
capitalizing the cost of the tools and depreciating the cost over two years. The owner asks
why the accountant spends so much time on "bookkeeping" and tells her to simply charge the
tools to expense when they are purchased. The accountant agrees.
 3. Lauren Fox owns a snow removal business in Maine. Customers who will be vacationing
in Florida for the winter must make a deposit of one-half of the seasonal rate on September 1,
the last date to make arrangements to have their sidewalks and driveways plowed throughout
the winter while they are gone. The balance is due on November 1. At the time deposits are
received, Fox records them as revenue. Refunds, if any, are treated as expenses at the time
they are made.
 4. The Dollar Store sells such items as discontinued products and merchandise purchased
from bankrupt companies. Freight costs on goods purchased are quite high. The company
adds the freight costs to the purchase price and treats the total as cost of its merchandise
inventory.
 5. Each year, Neuman Enterprises has a large number of uncollectible accounts. Neuman
charges uncollectible accounts to expense when they are deemed to be uncollectible. On the
average, an account is deemed to be uncollectible about 18 months after the due date of the
account.




65. Why is the cost principle dependent on the going concern assumption?




                                               14-21
         Chapter 014 Accounting Principles and Reporting Standards



66. What two tests must be met in order for revenues to be recognized?




67. How are the concepts of materiality and cost-benefit related?




68. Define and give an example of all modifying constraints on accounting principles.




69. The process used by FASB in developing conceptual framework statements reflects
deductive reasoning and involves which steps?




                                            14-22
         Chapter 014 Accounting Principles and Reporting Standards



70. Explain the following statement. "Investors and creditors expect to receive a cash flow
directly or indirectly from the business entity."




71. According to FASB's conceptual framework, what are the 4 assumptions that financial
statement users should assume that prepares of the statements have made in preparing the
statements?




72. Define the two aspects of the monetary unit assumption.




73. Why are notes important in financial statements and when should they be provided?




                                            14-23
         Chapter 014 Accounting Principles and Reporting Standards



74. What is the general rule-of-thumb for determining if an item is material?




                                            14-24
         Chapter 014 Accounting Principles and Reporting Standards

75. Match the accounting terms with the descriptions by entering the proper letter in the
space provided.




___ 1. The transparency notion is that information provided in the financial statements and the
notes accompanying them should provide a clear and accurate picture of the financial affairs
of the company. The key to this idea is that of disclosure
___ 2. All information that might affect the user's interpretation of the profitability and
financial condition of a business should be disclosed
___ 3. In a few limited cases the unusual operating characteristics of an industry, usually
based on risk, special accounting principles, and procedures have been developed. These may
not conform completely to GAAP for other industries
___ 4. If alternative treatments of items are of equal validity, the conservatism constraint
suggests that the alternative resulting in lowest profit should be used
___ 5. The concept that revenues and the costs incurred in earning those revenues should be
matched in the appropriate accounting periods
___ 6. With regards to revenue, it takes place only when cash, a financial claim, or other
consideration is received for the sale of goods or services
___ 7. Revenue is recognized when it has been earned and realized
___ 8. It is assumed that only those items and events that can be measured in monetary terms
are included in the financial statements. An inherent part of this assumption is that the
monetary unit is stable. Thus assets purchased one year may be combined in the accounts with
those purchased in other years even though the dollars used in each year actually may have
different purchasing power
___ 9. These are necessary characteristics that must be present in financial statements if they
are to be credible
___ 10. This is the concept that a business is separate from its owner or owners and the
financial statements reflect the affairs of the business, not those of the owner
___ 11. A basic framework developed by the FASB to provide conceptual guidelines for
financial accounting and statements. The most important features are statements of qualitative
features of statements, basic assumptions underlying statements, basic accounting principles,
and modifying constraints
___ 12. This is the governmental sector, represented in the accounting rulemaking process by
the Securities and Exchange Commission
___ 13. In some cases where an accounting item is deemed too small to affect a user's
decisions, the "required" accounting may be ignored


                                            14-25
         Chapter 014 Accounting Principles and Reporting Standards

___ 14. If accounting concepts suggest a particular accounting treatment for an item but it
appears that the theoretically correct treatment would require an unreasonable amount of
work, the accountant may analyze the benefits and costs of the preferred treatment to see if
the benefit gained from its adoption is justified by the cost
___ 15. The assumption that a business will continue to operate indefinitely
___ 16. The principle that requires assets and services to be recorded at their cost at the time
they are acquired and that, generally, long-term assets remain at historical costs in the asset
accounts
___ 17. The concept that information in financial statements cannot be selected or presented
in a way to favor one set of interested parties over another
___ 18. The idea that economic activities of an entity can be divided logically and identified
with specific time periods, such as the year or quarter
___ 19. This is the nongovernmental sector of society. In an accounting context it is the
business sector, represented in the accounting rule-making process by the Financial
Accounting Standards Board




                                              14-26
            Chapter 014 Accounting Principles and Reporting Standards Key


True / False Questions


1. The Financial Accounting Standards Board is an agency of the federal government.
FALSE


AACSB: Analytic
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-2
Level: Easy
Section: 1



2. Because financial statements must be objective and based on verifiable evidence, data
obtained from estimates cannot be presented.
FALSE


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Knowledge
Learning Objective: 14-4
Level: Easy
Section: 2



3. The concepts of objectivity and verifiability eliminate subjective decisions.
FALSE


AACSB: Analytic
AICPA FN: Decision Making
Bloom's: Comprehension
Learning Objective: 14-4
Level: Easy
Section: 2



4. Most businesses follow the general rule that revenue is recognized when cash is received.
FALSE


AACSB: Analytic
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2




                                             14-27
            Chapter 014 Accounting Principles and Reporting Standards Key



5. The concept of realization permits a company to recognize income whenever there is an
increase in the market value of the assets it holds.
FALSE


AACSB: Analytic
AICPA FN: Decision Making
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 1



6. The separate entity assumption permits businesses to record property and equipment as
assets that will provide benefits in future periods.
FALSE


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Comprehension
Learning Objective: 14-5
Level: Easy
Section: 2



7. For convenience, accountants assume that the value of money is stable or that changes in its
value are not great enough to affect the recorded financial data.
TRUE


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-5
Level: Easy
Section: 2



8. If an expenditure that is expected to benefit future periods is made during one accounting
period, the cost should be divided and charged as an expense during each period benefited.
TRUE


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 2




                                            14-28
            Chapter 014 Accounting Principles and Reporting Standards Key



9. Assets are recorded at cost when they are purchased, but the asset accounts are adjusted
each year to reflect changes in market value.
FALSE


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 2



10. The matching principle requires that all known costs be charged to the current period of
operations.
FALSE


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 2



11. Assets are carried on the books at historical cost until they are used.
TRUE


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2



12. The matching principle is being applied when the cost of equipment is depreciated over its
useful life.
TRUE


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 2




                                              14-29
            Chapter 014 Accounting Principles and Reporting Standards Key



13. Accountants use footnotes to financial statements to disclose information that may
influence investor decisions.
TRUE


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2



14. If too much of the cost of an asset is charged as depreciation expense in the present
period, the firm's net income will be understated in later periods.
FALSE


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2



15. A firm is following generally accepted accounting principles if it reports merchandise
inventory on the balance sheet at its expected selling price rather than at its cost.
FALSE


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2




                                             14-30
            Chapter 014 Accounting Principles and Reporting Standards Key


Fill in the Blank Questions


16. The SEC has authority to define accounting terms and to prescribe accounting procedures
used by all ____________________ held corporations.
publicly


AACSB: Analytic
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-2
Level: Medium
Section: 1



17. Financial accounting rules affect the recording of data used to prepare financial reports
that go to ____________________ and creditors.
investors


AACSB: Analytic
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-3
Level: Easy
Section: 1



18. Financial information is said to be ____________________ if it can be reviewed by
accountants outside the company, and these accountants arrive at the same conclusions as the
preparers of the firm's financial statements.
verifiable; objective


AACSB: Analytic
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-4
Level: Easy
Section: 2




                                             14-31
            Chapter 014 Accounting Principles and Reporting Standards Key



19. Revenue should not be recorded until it is ____________________; that is, until new
assets are created in the form of money or claims against others.
realized; earned


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-5
Level: Easy
Section: 2



20. The ____________________ assumption permits the costs of assets purchased many
years ago to be added to the costs of newly purchased assets for financial statement reporting.
stable monetary unit


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Comprehension
Learning Objective: 14-5
Level: Easy
Section: 2



21. The ____________________ assumption permits carrying forward a portion of the cost of
assets that will be used in future periods.
going concern


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-5
Level: Easy
Section: 2



22. An accountant generally assumes that a firm is a(n) ____________________ concern and
will continue to operate indefinitely.
going


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-5
Level: Easy
Section: 2




                                            14-32
            Chapter 014 Accounting Principles and Reporting Standards Key



23. If an important fact that would have an effect on an investor's decisions is omitted from
the financial statements, the ____________________ principle has been violated.
full disclosure


AACSB: Analytic
AICPA BB: Industry
Bloom's: Application
Learning Objective: 14-6
Level: Easy
Section: 2



24. The accountant records an expense for wages earned by employees during the last four
days of the year, even though the wages will not be paid in that year. The accountant is
following the ____________________ principle.
accrual; matching


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Application
Learning Objective: 14-6
Level: Easy
Section: 2



25. The ____________________ principle requires that if income is to be properly measured,
all expired costs associated with the earning of revenue must be deducted from the revenue.
matching


AACSB: Analytic
AICPA BB: Industry
Bloom's: Comprehension
Learning Objective: 14-6
Level: Easy
Section: 2




                                             14-33
            Chapter 014 Accounting Principles and Reporting Standards Key



26. If the ____________________ basis of accounting is used, income is recorded in the
period in which it is earned.
accrual


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2



27. The ____________________ basis of accounting means that business transactions are
recorded based on an "arm's length" transaction in the market.
historical cost


AACSB: Analytic
AICPA BB: Industry
Bloom's: Knowledge
Learning Objective: 14-6
Level: Easy
Section: 2



28. The modifying convention of ____________________ concerns the significance of an
item in relation to the particular situation of which it is a part.
materiality


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Knowledge
Learning Objective: 14-7
Level: Easy
Section: 2



29. Because of the modifying convention of ____________________, assets are understated
rather than overstated if any question exists.
conservatism


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Comprehension
Learning Objective: 14-7
Level: Easy
Section: 2




                                           14-34
            Chapter 014 Accounting Principles and Reporting Standards Key



30. Lack of ____________________ would result in financial reports that are not comparable
with earlier statements.
consistency


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Knowledge
Learning Objective: 14-4
Level: Easy
Section: 2




Multiple Choice Questions


31. In order to ensure that they are meaningful and useful, financial statements should be
prepared
A. in accordance with section 108 of the Sarbanes-Oxley Act.
B. on a daily basis.
C. on a timely basis.
D. using generally accepting accounting principles (GAAP).


AACSB: Reflective Thinking
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-1
Level: Easy
Section: 1



32. Which of the following statements is not correct?
A. The Securities and Exchange Commission (SEC) issues the Statements of Financial
Accounting Standards.
B. Statements issued by the Financial Accounting Standards Board (FASB) are binding on the
members of the American Institute of Certified Public Accountants (AICPA).
C. An act of law gave the SEC the authority to determine the form and content of accounting
reports filed by companies under its jurisdiction.
D. All of these statements are correct.


AACSB: Reflective Thinking
AICPA FN: Decision Making
Bloom's: Analysis
Learning Objective: 14-1
Level: Easy
Section: 1




                                            14-35
            Chapter 014 Accounting Principles and Reporting Standards Key



33. The Statements of Financial Accounting Standards that automatically become generally
accepted accounting principles are issued by
A. the IRS.
B. the SEC.
C. the FASB.
D. the AICPA.


AACSB: Analytic
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-2
Level: Easy
Section: 1



34. The Financial Accounting Standards Board is
A. a branch of the AICPA.
B. a branch of the IRS.
C. an independent organization.
D. a branch of the SEC.


AACSB: Analytic
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-2
Level: Easy
Section: 1



35. The Accounting Standards Executive Committee issues three important types of
documents
A. accounting and auditing guides.
B. statements of position.
C. practice bulletins.
D. all of these.


AACSB: Analytic
AICPA BB: Industry
Bloom's: Comprehension
Learning Objective: 14-2
Level: Easy
Section: 1




                                          14-36
            Chapter 014 Accounting Principles and Reporting Standards Key



36. In its conceptual framework, the FASB concluded that financial reporting rules should
concentrate on providing information that is helpful to
A. current and potential investors and creditors in making investment and credit decisions.
B. management, tax authorities, and regulatory agencies.
C. Both of the above.
D. Neither of the above.


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Analysis
Learning Objective: 14-3
Level: Easy
Section: 1



37. Investors and creditors expect to receive a cash flow from the business entity
A. directly from the distribution of the company's earnings.
B. indirectly through the disposition of their interests for cash.
C. Both of the above.
D. Neither of the above.


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Analysis
Learning Objective: 14-3
Level: Easy
Section: 1



38. Financial report users need information about
A. profits.
B. economic resources (assets).
C. claims against the assets (liabilities and owner's equity).
D. all of these.


AACSB: Reflective Thinking
AICPA BB: Industry
Bloom's: Analysis
Learning Objective: 14-3
Level: Easy
Section: 1




                                              14-37
            Chapter 014 Accounting Principles and Reporting Standards Key



39. The SEC's 2003 report to the Congress on "principles-based" accounting observed that the
first characteristic of objectives-based standards, dictated by the Sarbanes-Oxley Act, is that
any standard must be based on
A. the cost-benefit test.
B. an improved and consistently applied framework.
C. qualitative characteristics.
D. transparency.


AACSB: Analytic
AICPA BB: Legal
Bloom's: Knowledge
Learning Objective: 14-3
Level: Easy
Section: 1



40. Accounting information that is capable of making a difference in a decision by the report
user is
A. comparable.
B. reliable.
C. relevant.
D. neutral.


AACSB: Reflective Thinking
AICPA FN: Measurement
Bloom's: Analysis
Learning Objective: 14-4
Level: Medium
Section: 2



41. The Cervantes Company uses the same method of depreciation for its equipment in each
fiscal period. This practice is an example of
A. conservatism.
B. consistency.
C. materiality.
D. matching.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-4
Level: Medium
Section: 2




                                            14-38
            Chapter 014 Accounting Principles and Reporting Standards Key



42. The four assumptions financial statement users should be able to assume that preparers of
the statements have made in preparing the statements that are listed by the FASB's conceptual
framework are
A. separate economic entity, going concern, monetary unit, and periodicity of income.
B. conservatism, matching principle, revenue recognition principle, and periodicity of income.
C. conservatism, cost-benefit test, full disclosure principal, and industry practice constraint.
D. historical cost basis, materiality realization, and transparency.


AACSB: Reflective Thinking
AICPA FN: Reporting
Bloom's: Knowledge
Learning Objective: 14-5
Level: Hard
Section: 2



43. Which of the following statements is correct?
A. Under the accrual basis of accounting, revenue is recorded in the period in which it is
earned.
B. Under the accrual basis of accounting, expenses are recorded in the period in which they
are incurred.
C. Both of the above statements are correct.
D. Neither of the above statements is correct.


AACSB: Reflective Thinking
AICPA FN: Decision Making
Bloom's: Analysis
Learning Objective: 14-6
Level: Easy
Section: 2




                                             14-39
            Chapter 014 Accounting Principles and Reporting Standards Key



44. Each year there was an increase in the market value of some stock owned by the
Mudstream Company, but the accountant did not record the increase in asset value and equity
until the stock was sold. In this situation, the accountant
A. followed the matching principle.
B. followed the realization principle.
C. violated the accrual principle.
D. violated the matching principle.


AACSB: Reflective Thinking
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-6
Level: Medium
Section: 2



45. Keeping the personal assets of the owner of a business separate from the assets of the firm
is an example of
A. following the going concern assumption.
B. applying the realization principle.
C. following the separate entity assumption.
D. applying the conservatism convention.


AACSB: Reflective Thinking
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-5
Level: Medium
Section: 2



46. When Tamar Snyder opened a shoe store, her accountant did not include the cash in her
personal savings account as one of the assets of the business. This is an example of
A. the separate entity assumption.
B. the conservatism principle.
C. the materiality principle.
D. industry practice principle.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-5
Level: Medium
Section: 2




                                            14-40
            Chapter 014 Accounting Principles and Reporting Standards Key



47. Which of the following is allowed under generally accepted accounting principles?
A. A company was offered $60,000 for land that it had purchased for $15,000. The company
did not sell the land but increased the Land account to $60,000.
B. An owner lists the full cost of his or her personal automobile, which is occasionally used
for business purposes, on the company's balance sheet.
C. A large company recorded the $20 cost of a tool as an expense, although the item is
expected to be used for 3 years.
D. The Equipment account shows a balance of $55,000. This amount represents the original
cost of $75,000 less the accumulated depreciation of $20,000.


AACSB: Reflective Thinking
AICPA FN: Decision Making
Bloom's: Analysis
Learning Objective: 14-6
Level: Medium
Section: 2



48. Recording land at its cost rather than its appraisal value illustrates
A. the full disclosure principle.
B. the cost basis principle.
C. the realization principle.
D. the matching principle.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-6
Level: Medium
Section: 2



49. An accountant who records revenue when a credit sale is made rather than waiting for the
receipt of cash from the customer is
A. following the accrual principle.
B. following the conservatism convention.
C. violating generally accepted accounting principles.
D. following the consistency principle.


AACSB: Reflective Thinking
AICPA FN: Reporting
Bloom's: Comprehension
Learning Objective: 14-6
Level: Medium
Section: 2




                                               14-41
            Chapter 014 Accounting Principles and Reporting Standards Key



50. Depreciating equipment over its useful life is an example of
A. following the objectivity assumption.
B. applying the matching principle.
C. applying the realization principle.
D. applying the conservatism convention.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Analysis
Learning Objective: 14-6
Level: Medium
Section: 2



51. The financial statements in the annual report of a corporation contain footnotes explaining
the methods used to depreciate the firm's equipment. This practice is an example of
A. the consistency principle.
B. the conservatism principle.
C. the full disclosure principle.
D. the accrual principle.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Analysis
Learning Objective: 14-6
Level: Medium
Section: 2



52. The Garrison Company offers terms of net 30 days for its credit sales. It records the
revenue from these sales as soon as the sales are made rather than waiting until cash is
received from the customers. This is an example of the
A. realization principle.
B. matching principle.
C. conservatism principle.
D. consistency principle.


AACSB: Analytic
AICPA FN: Measurement
Bloom's: Analysis
Learning Objective: 14-6
Level: Medium
Section: 2




                                             14-42
            Chapter 014 Accounting Principles and Reporting Standards Key



53. A deviation from generally accepted accounting principles is
A. permissible if the amount involved is material.
B. permissible if the amount involved is immaterial.
C. never allowed.
D. permissible only if its required in order to conform to the monetary unit assumption.


AACSB: Analytic
AICPA FN: Reporting
Bloom's: Comprehension
Learning Objective: 14-7
Level: Medium
Section: 2



54. An accountant charged the Repairs Expense account for a tool that cost $12. The tool had
an estimated useful life of 5 years; however, the accountant did not choose to depreciate it.
The modifying convention that the accountant followed was
A. materiality.
B. objectivity.
C. conservatism.
D. industry practice.


AACSB: Reflective Thinking
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-7
Level: Medium
Section: 2



55. When a new company was formed, one partner contributed some used equipment he
owned. The equipment was appraised at $44,000 and $50,000 by two different dealers. The
accountant entered the equipment at $44,000 in the financial records of the partnership. This
is an example of
A. the materiality principle.
B. the conservatism principle.
C. the matching principle.
D. industry practice principle.


AACSB: Reflective Thinking
AICPA FN: Measurement
Bloom's: Application
Learning Objective: 14-7
Level: Medium
Section: 2




                                            14-43
            Chapter 014 Accounting Principles and Reporting Standards Key


Essay Questions


56. What is meant by the concept of neutrality in accounting?

Neutrality means that the statements are prepared without bias and without attempting to
portray a predetermined picture. The needs of all users are considered equally.


AACSB: Analytic
AICPA BB: Industry
Bloom's: Analysis
Learning Objective: 14-4
Level: Easy
Section: 2




                                           14-44
            Chapter 014 Accounting Principles and Reporting Standards Key

57. Match the qualitative characteristics of accounting information with the descriptions by
entering the proper letter in the space provided.

A. Comparability
B. Consistency
C. Feedback value
D. Neutrality
E. Predictive value
F. Relevance
G. Reliability
H. Representational faithfulness
I. Timeliness
J. Verifiability
___ 1. Information that helps the statement user confirm fulfillment or no fulfillment of prior
expectations or decisions is said to have this qualitative characteristic.
___ 2. This qualitative characteristic means simply that the information should be dependable;
such information is verifiable, is a faithful representation of the company's financial affairs,
and is reasonably free of error and bias.
___ 3. This qualitative characteristic means that accounting information is capable of making
a difference in a decision by the report user.
___ 4. If an entity uses the same accounting treatment for similar events and data from period
to period, this qualitative characteristic is being met.
___ 5. If information is relevant, it will have this qualitative characteristic and enable
statement users in making predictions about the meaning and ultimate outcome of events
giving rise to the information.
___ 6. This qualitative characteristic is indicated when independent measurers obtain similar
results.
___ 7. Information that is presented soon enough after events are reported to be useful in
decision making would meet this qualitative characteristic.
___ 8. This is the concept that data shown in the financial reports reflect what really
happened.
___ 9. Often referred to as objectivity; it is the idea that the financial statements are not
prepared in a way to favor one group of users (management, owners, creditors, employees,
etc.) over other groups.
___ 10. When the financial data is presented in such a manner that it can be meaningfully
compared with the same data for other companies, it meets this qualitative characteristic.

(1) C, (2) G, (3) F, (4) B, (5) E, (6) J, (7) I, (8) H, (9) D, (10) A


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-4
Level: Hard
Section: 2




                                                14-45
            Chapter 014 Accounting Principles and Reporting Standards Key



58. In recent years, it has been reported that several large companies have manipulated
business transactions and accounting records to change the net income reported on their
income statements. Suggest five concepts, assumptions, principles, or conventions that such
manipulation would violate.

Misstating net income on the income statement violates the neutrality, matching, revenue
recognition, reliability, and comparability concepts.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Synthesis
Learning Objective: 14-4
Learning Objective: 14-6
Level: Medium
Section: 2




                                           14-46
         Chapter 014 Accounting Principles and Reporting Standards Key

59. The income statement shown below was prepared and sent by Jenna Preston, the owner
of Preston Gifts, to several of her creditors. The business is a sole proprietorship that sells
miscellaneous gifts. An accountant for one of the creditors looked over the income statement
and found that it did not conform to generally accepted accounting principles. Using the
following additional information provided by the owner, prepare an income statement in
accordance with generally accepted accounting principles.




 Additional information provided by owner:
 1. All sales were for cash.
 2. The beginning and ending merchandise inventories were valued at their estimated selling
price. The actual cost of the ending inventory is estimated to be $12,000. The actual cost of
the beginning inventory is estimated to be $20,000.
 3. On December 31, 2011, suppliers of merchandise are owed $11,000. On January 1, 2012,
they were owed $14,000.
 4. The owner paid herself a salary of $1,250 per month and charged this amount to the Salary
of Owner account.
 5. A check for $800 to cover the December rent on the owner's personal apartment was
issued from the firm's bank account. This amount was charged to Rent Expense.




                                             14-47
            Chapter 014 Accounting Principles and Reporting Standards Key




AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Synthesis
Learning Objective: 14-5
Learning Objective: 14-6
Level: Hard
Section: 2




                                        14-48
         Chapter 014 Accounting Principles and Reporting Standards Key

60. The income statement shown below was prepared and sent by Curtis Brown, the owner of
Curt's Crafts, to several of his creditors. The business is a sole proprietorship that sells crafts
and toys. An accountant for one of the creditors looked over the income statement and found
that it did not conform to generally accepted accounting principles. Using the following
additional information provided by the owner, prepare an income statement in accordance
with generally accepted accounting principles.




 Additional information provided by owner:
 1. On December 31, 2011, accounts receivable from customers total $32,000. On January 1,
2012, accounts receivable totaled $52,000.
 2. The beginning and ending merchandise inventories were valued at their estimated selling
price. The actual cost of the ending inventory is estimated to be $6,000. The actual cost of the
beginning inventory is estimated to be $18,000.
 3. On December 31, 2011 suppliers of merchandise are owed $16,000. On January 1, 2012,
they were owed $11,000.
 4. The owner paid himself a salary of $1,600 per month and charged this amount to the
Salaries Expense account.
 5. A check for $300 to cover the December electric bill on the owner's personal home was
issued from the firm's bank account. This amount was charged to Utilities Expense.




                                              14-49
            Chapter 014 Accounting Principles and Reporting Standards Key




AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Synthesis
Learning Objective: 14-5
Learning Objective: 14-6
Level: Hard
Section: 2




                                        14-50
         Chapter 014 Accounting Principles and Reporting Standards Key

61. Carlos Verde owns a small nursery. He recently approached the local bank for a loan to
finance an expansion of his nursery. Carlos prepared the balance sheet given below and
submitted it with his loan application. The balance sheet does not conform to generally
accepted accounting principles. Using the additional information provided by the owner,
prepare a corrected balance sheet in accordance with generally accepted accounting
principles.




 Additional information provided by owner:
 1. The inventory has an original cost of $42,000. It is listed on the balance sheet at what it
would cost to purchase today.
 2. Included in the cash listed on the balance sheet is $4,000 in Carlos Verde's personal
checking account.
 3. Depreciation allowable to date on the equipment is $5,000. Depreciation allowable to date
on the truck is $3,000.




                                             14-51
            Chapter 014 Accounting Principles and Reporting Standards Key




AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Synthesis
Learning Objective: 14-5
Learning Objective: 14-6
Level: Hard
Section: 2




                                        14-52
         Chapter 014 Accounting Principles and Reporting Standards Key

62. Antonio Hanley owns a small automobile service center. He recently approached the
local bank for a loan to finance an expansion of his service center. Antonio prepared the
balance sheet given below and submitted it with his loan application. The balance sheet does
not conform to generally accepted accounting principles. Using the additional information
provided by the owner, prepare a corrected balance sheet in accordance with generally
accepted accounting principles.




 Additional information provided by owner:
 1. The inventory has an original cost of $84,000. It is listed on the balance sheet at what it
would cost to purchase today.
 2. Included in the cash listed on the balance sheet is $8,000 in Antonio Hanley's personal
checking account.
 3. Depreciation allowable to date on the equipment is $10,000. Depreciation allowable to
date on the truck is $6,000.




                                              14-53
            Chapter 014 Accounting Principles and Reporting Standards Key




AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Synthesis
Learning Objective: 14-5
Learning Objective: 14-6
Level: Hard
Section: 2




                                        14-54
            Chapter 014 Accounting Principles and Reporting Standards Key



63. Indicate in each case whether the item has been handled in accordance with generally
accepted accounting principles (GAAP). If so, indicate the key basic concept that has been
followed. If not, indicate which concept has been violated and tell how the item should have
been recorded or presented.

 1. A piece of machinery has a book value (cost less accumulated depreciation) of $90,000.
However, the machinery could not be sold for more than $70,000 today. The company's
owner thinks that the machinery should nevertheless be reported on the balance sheet at
$90,000 and depreciated over its useful life, because the equipment is being used regularly in
the business and it is expected to be used for the next five years—the remaining useful life
that is being used for depreciation purposes.
 2. At the beginning of the year, the company bought a building for $1,000,000. At the end of
the year, the building's value was appraised at $1,220,000. Since there was an increase in
value, the company did not record depreciation on the building.
 3. The assets listed in the accounting records of the company, which is operated as a sole
proprietorship, include a savings account of the owner of the business. The owner established
the savings account so that if she needs to invest more cash in the business, it will be readily
available.
 4. Three years ago, the company paid for a three-year insurance policy on its automobiles by
writing a check for $6,000. At the end of the current year, the balance sheet of the company
reported prepaid insurance at $6,000.

 1. Yes; cost basis and matching
2. No; matching principle violated; Depreciation expense is recognized over the periods in
which the asset is expected to help earn revenues for the business.
3. No; separate entity assumption violated; The owner's personal savings account should be
separate from the business and not reported in the accounting records.
4. No; matching principle violated; They should have reported prepaid insurance at $6,000
three years ago when the policy was purchased.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Evaluation
Learning Objective: 14-4
Learning Objective: 14-5
Learning Objective: 14-6
Level: Easy
Section: 2




                                             14-55
         Chapter 014 Accounting Principles and Reporting Standards Key

64. For each of the unrelated situations below, identify the accounting principle or concept
violated (if a violation exists) and explain the nature of the violation. If you believe that the
treatment is in accordance with GAAP, state the major principle or concept in support.

 1. White Farm Equipment Company manufactures tractors and combines. It pays its
salespeople a commission of 15 percent of the sales price as their remuneration. During the
current year, the company's sales were $100,000,000 and commissions amounted to
$15,000,000. In the income statement, sales are shown as $100,000,000.
 2. Plato Plastics Molding uses a large quantity of small tools in its manufacturing process.
The annual purchases of the tools, which have a life of about two years, are approximately 1
percent of the company's net income for the year. The company has followed the practice of
capitalizing the cost of the tools and depreciating the cost over two years. The owner asks
why the accountant spends so much time on "bookkeeping" and tells her to simply charge the
tools to expense when they are purchased. The accountant agrees.
 3. Lauren Fox owns a snow removal business in Maine. Customers who will be vacationing
in Florida for the winter must make a deposit of one-half of the seasonal rate on September 1,
the last date to make arrangements to have their sidewalks and driveways plowed throughout
the winter while they are gone. The balance is due on November 1. At the time deposits are
received, Fox records them as revenue. Refunds, if any, are treated as expenses at the time
they are made.
 4. The Dollar Store sells such items as discontinued products and merchandise purchased
from bankrupt companies. Freight costs on goods purchased are quite high. The company
adds the freight costs to the purchase price and treats the total as cost of its merchandise
inventory.
 5. Each year, Neuman Enterprises has a large number of uncollectible accounts. Neuman
charges uncollectible accounts to expense when they are deemed to be uncollectible. On the
average, an account is deemed to be uncollectible about 18 months after the due date of the
account.




                                               14-56
            Chapter 014 Accounting Principles and Reporting Standards Key

 1. No; revenue recognition principle and full disclosure concept violated; The company must
account for payment of $15,000,000 in commissions.
2. No; materiality and cost-benefits constraints violated; The accountant's approach
conceptually correct, but materiality and cost-benefits constraints support the owner's
instructions
3. No; revenue recognition principle violated; The deposits should be treated as prepaid assets
not revenue since the service has not provided.
4. Yes; matching principle;
5. No; matching concept violated Freight costs should be listed separately on the income
statement.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Evaluation
Learning Objective: 14-5
Learning Objective: 14-6
Learning Objective: 14-7
Level: Hard
Section: 2



65. Why is the cost principle dependent on the going concern assumption?

Unless there is evidence to the contrary, it is assumed that a business will continue to operate
indefinitely as a going concern. On the other hand, if evidence exists that a business will not
be able to continue in existence as a going concern, the only useful information would be the
value of the assets. Therefore, reporting the assets of a business that is not a going concern at
cost would provide useless information. In such a case, the costs of assets are immaterial,
GAAP may be less important, and other factors such as the cost of applying GAAP may take
precedence.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Evaluation
Learning Objective: 14-6
Level: Hard
Section: 2




                                              14-57
            Chapter 014 Accounting Principles and Reporting Standards Key



66. What two tests must be met in order for revenues to be recognized?

Revenues must have been earned and they must have been realized before they can be
recognized.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-6
Level: Medium
Section: 2



67. How are the concepts of materiality and cost-benefit related?

If an item is immaterial, there is less justification for incurring substantial costs to comply
with GAAP regarding the item. The cost of compliance may outweigh the benefits. If an item
is highly material, then cost becomes less important.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Evaluation
Learning Objective: 14-7
Level: Medium
Section: 2




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            Chapter 014 Accounting Principles and Reporting Standards Key



68. Define and give an example of all modifying constraints on accounting principles.

A. Materiality; Materiality refers to the significance of an item of financial data in relation to
other financial data; ABC Enterprise is a Fortune 500 company which purchased equipment
for $1,000. The company decides to charge the cost to expense because the amount is
insignificant in comparison its net income.
B. Cost-Benefit Test; Determines whether the cost of complying with an accounting principle
or standard is justified by the benefit which would result if the preferred treatment is
followed. An accountant spends more time accounting for each individual store fixture than
she does accounting for all other aspects of the business. Since there are over 100 different
types of fixtures and the cost is less than 1% of net income, the method of individually
accounting for each fixture does not pass the cost benefit test.
C. Conservatism; If there is no clear evidence of how a transaction should be accounted for,
the accountant should choose the conservative approach. An accountant is unsure of the
useful life of a new machine just purchased. The manufacturer estimates the life at 10 years.
However, the Warehouse Manager believes the machine will last twice as long based on prior
experience. In accordance with conservatism, the accountant should use the manufacturer's
estimate.
D. Industry Practice; Certain existing accounting practices within an industry which have
become acceptable as GAAP; Public utility regulatory agencies allowed interest to be
included in the cost of the plant rather than being charged to a separate interest expense
account.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Analysis
Learning Objective: 14-7
Level: Medium
Section: 2




                                              14-59
            Chapter 014 Accounting Principles and Reporting Standards Key



69. The process used by FASB in developing conceptual framework statements reflects
deductive reasoning and involves which steps?

1. Define the goals and objectives of accounting.
2. Identify users of financial reports and the uses made of the reports.
3. Examine the qualitative characteristics that make accounting information useful.
4. Identify and define the financial elements such as assets, liabilities, revenues, and expenses.
5. Establish the form and content of financial statements.
6. Set forth fundamental recognition criteria.
7. Develop measurement standards for financial elements that appear in the financial
statements.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Analysis
Learning Objective: 14-2
Level: Medium
Section: 1



70. Explain the following statement. "Investors and creditors expect to receive a cash flow
directly or indirectly from the business entity."

Investors and creditors expect to receive a cash flow directly from the distribution of the
company's earnings or indirectly through the disposition of the interests for cash.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Analysis
Learning Objective: 14-3
Level: Medium
Section: 1




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            Chapter 014 Accounting Principles and Reporting Standards Key



71. According to FASB's conceptual framework, what are the 4 assumptions that financial
statement users should assume that prepares of the statements have made in preparing the
statements?

1. Separate economic entity assumption
2. Going concern
3. Monetary unit
4. Periodicity of income


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-5
Level: Medium
Section: 2



72. Define the two aspects of the monetary unit assumption.

1. Expressing financial facts and events are meaningful only when they can be expressed in
monetary terms.
2. The value of money is stable.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-5
Level: Medium
Section: 2



73. Why are notes important in financial statements and when should they be provided?

1. The notes provide integral and extended details for items shown in the financial statements.
2. Supplemental information may be required by FASB or SEC, or it may be voluntary.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-6
Level: Hard
Section: 2




                                            14-61
            Chapter 014 Accounting Principles and Reporting Standards Key



74. What is the general rule-of-thumb for determining if an item is material?

If the item or total of items is less than 5% of net income it is not material.


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Evaluation
Learning Objective: 14-7
Level: Hard
Section: 2




                                               14-62
         Chapter 014 Accounting Principles and Reporting Standards Key

75. Match the accounting terms with the descriptions by entering the proper letter in the space
provided.




___ 1. The transparency notion is that information provided in the financial statements and the
notes accompanying them should provide a clear and accurate picture of the financial affairs
of the company. The key to this idea is that of disclosure
___ 2. All information that might affect the user's interpretation of the profitability and
financial condition of a business should be disclosed
___ 3. In a few limited cases the unusual operating characteristics of an industry, usually
based on risk, special accounting principles, and procedures have been developed. These may
not conform completely to GAAP for other industries
___ 4. If alternative treatments of items are of equal validity, the conservatism constraint
suggests that the alternative resulting in lowest profit should be used
___ 5. The concept that revenues and the costs incurred in earning those revenues should be
matched in the appropriate accounting periods
___ 6. With regards to revenue, it takes place only when cash, a financial claim, or other
consideration is received for the sale of goods or services
___ 7. Revenue is recognized when it has been earned and realized
___ 8. It is assumed that only those items and events that can be measured in monetary terms
are included in the financial statements. An inherent part of this assumption is that the
monetary unit is stable. Thus assets purchased one year may be combined in the accounts with
those purchased in other years even though the dollars used in each year actually may have
different purchasing power
___ 9. These are necessary characteristics that must be present in financial statements if they
are to be credible
___ 10. This is the concept that a business is separate from its owner or owners and the
financial statements reflect the affairs of the business, not those of the owner
___ 11. A basic framework developed by the FASB to provide conceptual guidelines for
financial accounting and statements. The most important features are statements of qualitative
features of statements, basic assumptions underlying statements, basic accounting principles,
and modifying constraints
___ 12. This is the governmental sector, represented in the accounting rulemaking process by
the Securities and Exchange Commission
___ 13. In some cases where an accounting item is deemed too small to affect a user's
decisions, the "required" accounting may be ignored


                                            14-63
            Chapter 014 Accounting Principles and Reporting Standards Key

___ 14. If accounting concepts suggest a particular accounting treatment for an item but it
appears that the theoretically correct treatment would require an unreasonable amount of
work, the accountant may analyze the benefits and costs of the preferred treatment to see if
the benefit gained from its adoption is justified by the cost
___ 15. The assumption that a business will continue to operate indefinitely
___ 16. The principle that requires assets and services to be recorded at their cost at the time
they are acquired and that, generally, long-term assets remain at historical costs in the asset
accounts
___ 17. The concept that information in financial statements cannot be selected or presented
in a way to favor one set of interested parties over another
___ 18. The idea that economic activities of an entity can be divided logically and identified
with specific time periods, such as the year or quarter
___ 19. This is the nongovernmental sector of society. In an accounting context it is the
business sector, represented in the accounting rule-making process by the Financial
Accounting Standards Board

(1) S, (2) D, (3) G, (4) B, (5) H, (6) P, (7) Q, (8) J, (9) O, (10) R, (11) A (12) N, (13) I, (14) C,
(15) E, (16) F, (17) K, (18) L, (19) M


AACSB: Analytic
AICPA BB: Critical Thinking
Bloom's: Knowledge
Learning Objective: 14-1
Learning Objective: 14-2
Learning Objective: 14-3
Learning Objective: 14-4
Learning Objective: 14-5
Learning Objective: 14-6
Learning Objective: 14-7
Learning Objective: 14-8
Level: Hard
Section: 1, 2




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