Chapter 1
Introduction to Financial Reporting
QUESTIONS
1- 1. a. The AICPA is an organization of CPAs that prior to 1973 accepted the
primary responsibility for the development of generally accepted
accounting principles. Their role was substantially reduced in 1973 when
the Financial Accounting Standards Board was established. Their role
was further reduced with the establishment of the Public Company
Accounting Oversight Board was established in 2002.
b. The Financial Accounting Standards Board replaced the Accounting
Principles Board as the primary rule-making body for accounting
standards. It is an independent organization and includes members
other than public accountants.
c. The SEC has the authority to determine generally accepted accounting
principles and to regulate the accounting profession. The SEC has
elected to leave much of the determination of generally accepted
accounting principles to the private sector. The Financial Accounting
Standards Board has played the major role in establishing accounting
standards since 1973. Regulation of the accounting profession was
substantially turned over to the Public Company Accounting Oversight
Board in 2002.
1- 2. Consistency is obtained through the application of the same accounting
principle from period to period. A change in principle requires statement
disclosure.
1- 3. The concept of historical cost determines the balance sheet valuation of land.
The realization concept requires that a transaction needs to occur for the profit
to be recognized.
1- 4. a. Entity e. Historical cost
b. Realization f. Historical cost
c. Materiality g. Disclosure
d. Conservatism
1- 5. Entity concept
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,1- 6. Generally accepted accounting principles do not apply when a firm does not
appear to be a going concern. If the decision is made that this is not a going
concern, then the use of GAAP would not be appropriate.
1- 7. With the time period assumption, inaccuracies of accounting for the entity,
short of its complete life span, are accepted. The assumption is made that the
entity can be accounted for reasonably accurately for a particular period of
time. In other words, the decision is made to accept some inaccuracy
because of incomplete information about the future in exchange for more
timely reporting. The statements are considered to be meaningful because
material inaccuracies are not acceptable.
1- 8. It is true that the only accurate way to account for the success or failure of an
entity is to accumulate all transactions from the opening of business until the
business eventually liquidates. But it is not necessary that the statements be
completely accurate in order for them to be meaningful.
1- 9. a. A year that ends when operations are at a low ebb for the year.
b. The accounting time period is ended on December 31.
c. A twelve-month accounting period that ends at the end of a month other
than December 31.
1-10. Money.
1-11. When money does not hold a stable value, the financial statements can lose
much of their significance. To the extent that money does not remain stable,
it loses usefulness as the standard for measuring financial transactions.
1-12. No. There is a problem with determining the index in order to adjust the
statements. The items that are included in the index must be representative.
In addition, the prices of items change because of various factors, such as
quality, technology, and inflation.
Yes. A reasonable adjustment to the statements can be made for inflation.
1-13. False. An arbitrary write-off of inventory cannot be justified under the
conservatism concept. The conservatism concept can only be applied where
there are alternative measurements and each of these alternative
measurements has reasonable support.
1-14. Yes, inventory that has a market value below the historical cost should be
written down in order to recognize a loss. This is done based upon the
concept of conservatism. Losses that can be reasonably anticipated should
be taken in order to reflect the least favorable effect on net income of the
current period.
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© 2013 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
,1-15. End of production
The realization of revenue at the completion of the production process is
acceptable when the price of the item is known and there is a ready market.
Receipt of cash
This method should only be used when the prospects of collection are
especially doubtful at the time of sale.
During production
This method is allowed for long-term construction projects because
recognizing revenue on long-term construction projects as work progresses
tends to give a fairer picture of the results for a given period in comparison
with having the entire revenue realized in one period of time.
1-16. It is difficult to apply the matching concept when there is no direct connection
between the cost and revenue. Under these circumstances, accountants
often charge off the cost in the period incurred in order to be conservative.
1-17. If the entity can justify the use of an alternative accounting method on the
basis that it is rational, then the change can be made.
1-18. The accounting reports must disclose all facts that may influence the
judgment of an informed reader. Usually this is a judgment decision for the
accountant to make. Because of the complexity of many businesses and the
increased expectations of the public, the full disclosure concept has become
one of the most difficult concepts for the accountant to apply.
1-19. There is a preference for the use of objectivity in the preparation of financial
statements, but financial statements cannot be completely prepared based
upon objective data; estimates must be made in many situations.
1-20. This is a true statement. The concept of materiality allows the accountant to
handle immaterial items in the most economical and expedient manner
possible.
1-21. Some industry practices lead to accounting reports that do not conform to
generally accepted accounting principles. These reports are considered to be
acceptable, but the accounting profession is making an effort to eliminate
particular industry practices that do not conform to the normal generally
accepted accounting principles.
1-22. Events that fall outside of the financial transactions of the entity are not
recorded. An example would be the loss of a major customer.
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© 2013 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
, 1-23. True. The accounting profession is making an effort to reduce or eliminate
specific industry practices.
1-24. The entity must usually use the accrual basis of accounting. Only under
limited circumstances can the entity use the cash basis.
1-25. The FASB commenced the Accounting Standards Codification™ project to
provide a single source of authoritative U.S. GAAP and provide one level of
authoritative GAAP.
1-26. The separate entity concept directs that personal transactions of the owners
must be kept separate from their business transactions.
1-27. At the point of sale
1-28. a. The building should be recorded at cost, which is $50,000.
b. Revenue should not be recorded for the savings between the cost of
$50,000 and the bid of $60,000. Revenue comes from selling, not from
purchasing.
1-29. The materiality concept supports this policy.
1-30. The Securities and Exchange Commission (SEC).
1-31. The basic problem with the monetary assumption when there has been
significant inflation is that the monetary assumption assumes a stable dollar in
terms of purchasing power. When there has been inflation, the dollar has not
been stable in terms of purchasing power, and therefore, dollars are being
compared that are not of the same purchasing power.
1-32. The matching principle deals with the costs to be matched against revenue.
The realization concept has to do with the determination of revenue. The
combination of revenue and costs determine income.
1-33. The term "generally accepted accounting principles" is used to refer to
accounting principles that have substantial authoritative support.
1-34. The process of considering a Statement of Financial Accounting Standards
begins when the Board elects to add a topic to its technical agenda. The
Board only considers topics that are "broken" for its technical agenda.
On projects with a broad impact, a Discussion Memorandum or an Invitation
to Comment is issued. The Discussion Memorandum or Invitation to
Comment is distributed as a basis for public comment. After considering the
written comments and the public hearing comments, the Board resumes
deliberations in one or more public Board meetings. The final Statement on
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© 2013 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
