Chapter 01 - Environment and Theoretical Structure of Financial Accounting

Chapter 01 Environment and Theoretical Structure of Financial Accounting Answer Key

True / False Questions

1 The primary function of financial accounting is to provide relevant financial information to parties e!ternal to "usiness enterprises TRUE

# Accrual accounting attempts to measure revenues and e!penses that occurred during accounting periods so they e$ual net operating cash flow FALSE

% The FAS& is currently the pu"lic sector organi'ation responsi"le for setting accounting standards in the ( S FALSE

) The *u"lic +eform and ,nvestor *rotection Act of #00# -Sar"anes-.!ley/ changed the entity responsi"le for setting auditing standards in the (nited States TRUE

0 A rules-"ased approach to standard setting stresses professional 1udgment as opposed to following a list of rules FALSE

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

2 (nder federal securities laws3 the SEC has the authority to set accounting standards in the (S TRUE

4 The primary responsi"ility for properly applying 5AA* when communicating with investors and creditors through financial statements lies with a firm6s auditors FALSE

7 Auditors play an important role in the resource allocation process "y adding credi"ility to financial statements TRUE

8 9ateriality can "e affected "y the dollar amount of an item3 the nature of the item3 or "oth TRUE

10 Conservatism is a desired $ualitative characteristic of accounting information FALSE 11 E$uity is a residual amount representing the owner6s interest in the assets of the "usiness TRUE

1# +evenues are inflows or other enhancements of assets or settlements of lia"ilities from activities that constitute the entity6s ongoing operations TRUE 1% 5ains or losses result3 respectively3 from the disposition of "usiness assets for greater than3 or less than3 their "oo: values TRUE

1) Comprehensive income is another term for net income FALSE

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

10 ;etermining fair value "y calculating the present value of future cash flows is a level 1 type of input FALSE

12 The FAS&6s framewor: for measuring fair value doesn6t change the situations in which fair value is used under current 5AA* TRUE

Matching Questions

14 <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 # % ) 0 *redictive value +elevance ;istri"ution to owners Confirmatory value Timeliness ,nformation is useful in pro1ecting cash flows *ertinent to the decision at hand ,nformation is availa"le prior to the decision ;ecrease in e$uity due to transfers to owners ,nformation confirms e!pectations 1 2 5 3 4

17 <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase Along with relevance3 a fundamental decision1 5ain specific $uality 5 # 9ateriality +esults if an asset is sold for more than "oo: value 1 ,nformation contains all information necessary for % Completeness faithful representation 3 ) Comprehensive income The change in e$uity from nonowner transactions 4 0 Faithful Concerns the decision-ma:ing impact of "oth the representation amount and nature of an item 2

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

18 <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term with their phrases "y placing the letter designating the "est term in the space provided "y the phrase 1 =eutrality ,mportant in analysis "etween firms 2 # Compara"ility Accounting information should "e un"iased 1 % Consistency The process of including data in financial statements 5 ) Cost effectiveness Applying the same accounting practices over time 3 Considers the value of using information relative to 0 +ecognition cost of providing it 4

#0 <isted "elow are ten terms are followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 9onetary unit assumption # >erifia"ility % Economic entity assumption ) 5oing concern assumption 0 *eriodicity assumption

,mplies consensus among different o"servers Assumes all transactions can "e identified with a particular entity Assumes an entity will continue to operate indefinitely +e$uires reporting the financial life of an entity in discrete time frames ,gnores the possi"ility of inflation

2 3 4 5 1

#1 <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 ?istorical cost principle &asis of measurement for fi!ed assets 1 +ecognition of revenue only after certain criteria # 9ateriality are satisfied 5 % 9atching principle 5uide to e!pense recognition 3 ) Full-disclosure +eporting of all information that could affect principle decisions 4 Application of 5AA* sometimes avoided under 0 +eali'ation principle this constraint 2

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

## <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 Financial Accounting Standards &oard # Accounting *rinciples &oard % Conservatism ) A,C*A 0 Securities and E!change Commission ,t is a practical 1ustification for choosing among alternative accounting methods 3 ,t esta"lished 5AA* "efore the FAS& ,ts EITF Issues are 5AA* when entered in the Accounting Standards Codification ,t has the authority to set ( S accounting standards ,t is the national organi'ation for C*As in the (S 2 1 5 4

#% <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 E!penses =et assets 2 # E$uity .utflows of resources to generate revenues 1 % ;istri"utions to owners Cash dividends 3 ) ,nvestments "y owners Claims of creditors against the assets of a "usiness 5 Transfers of resources in e!change for common and 0 <ia"ilities preferred stoc: 4 #) <isted "elow are ten terms followed "y a list of phrases that descri"e or characteri'e five of the terms 9atch each phrase with the correct term "y placing the letter designating the "est term in the space provided "y the phrase 1 <osses =et outflows from peripheral transactions 1 ,ncreases in e$uity from the sale of goods and@or # Assets services 3 +esults if an asset is sold for more than "oo: % +evenues value 5 ) Comprehensive income All changes in e$uity e!cept owner transactions 4 *ro"a"le future economic "enefits controlled "y 0 5ains an entity 2

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

#0 <isted "elow are ten organi'ations followed "y a list of phrases that descri"e or characteri'e the organi'ations 9atch each phrase with the correct organi'ation "y placing the letter designating the "est term in the space provided "y the phrase Esta"lishes auditing standards in the ( S for pu"lic companies *rimary national organi'ation of accountants wor:ing in industry Sets accounting standards in the ( S *rovides timely responses to financial reporting issues The FAS&6s parent organi'ation *arent organi'ation of the ,AS& FAS&6s predecessor +egulates the financial reporting for pu"lic companies =ational organi'ation of certified pu"lic accountants Sets glo"al accounting standards

1 SEC # FAS& % ,AS& ) A,C*A 0 E,TF 2 *CA.& 4 ,9A 7 ,ASC 8 A*& 10 FAF

6 2 5 1! " # 1 4 3

Multi$le %hoice Questions

#2 E!ternal decision ma:ers would not loo: primarily to financial accounting information to assist them in ma:ing decisions onA A 5ranting credit &' Capital "udgeting C Selecting stoc:s ; 9ergers and ac$uisitions

#4 Corporations issue their shares to the investing pu"lic in theA

A .ption A & .ption & %' .ption C ; .ption ;

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

#7 The primary focus for financial accounting information is to provide information useful forA

A' .ption A & .ption & C .ption C ; .ption ; #8 Bhich of the following is not true a"out net operating cash flowC A ,t is the difference "etween cash receipts and cash dis"ursements from providing goods and services &' ,t is a measure used in accrual accounting and is recogni'ed as the "est predictor of future operating cash flows C .ver short periods of time3 it may not "e indicative of long-run cash-generating a"ility ; ,t is easy to understand and all information re$uired to measure it is factual %0 Bhich of the following groups is not among financial intermediariesC A 9utual fund managers & Financial analysts %' C*As ; Credit rating organi'ations %1 Bhich of the following was the first private sector entity that set accounting standards in the (nited StatesC A Accounting *rinciples &oard &' Committee on Accounting *rocedure C Financial Accounting Standards &oard ; A,C*A

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

%# Bhich of the following does not apply to secondary mar:etsC A Transactions are important to the efficient allocation of resources in our economy &' =ew resources are provided when shares of stoc: are sold "y the corporation to the initial owners C Transactions help to esta"lish mar:et prices for additional shares that may "e issued in the future ; 9any investors might "e unwilling to provide resources to corporations if there is no availa"le mechanism for the future sale of their stoc:s and "onds to others %% A cause-and-effect relationship is implicit in theA A +eali'ation principle & ?istorical cost principle %' 9atching principle ; 5oing concern assumption %) The full disclosure principle re$uires a "alance "etweenA A Compara"ility and consistency &' +elevance and cost effectiveness C +elia"ility and neutrality ; Timeliness and predictive value %0 Bhich of the following groups is not among the e!ternal users for whom financial statements are preparedC A Customers & Suppliers C Employees (' All of the a"ove are e!ternal users of financial statements %2 ,n a recent annual report3 Apple Computer reported the following in one of its disclosure notesA DBarranty E!penseA The Company provides currently for the estimated cost for product warranties at the time the related revenue is recogni'ed D This note e!emplifies Apple6s use ofA A Conservatism &' The matching principle C +eali'ation principle ; Economic entity

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

%4 5AA* is an a""reviation forA A 5enerally authori'ed accounting procedures & 5enerally applied accounting procedures C 5enerally accepted auditing practices (' 5enerally accepted accounting principles

%7 The SEC issues accounting standards in the form ofA A Accounting +esearch &ulletins &' Financial +eporting +eleases C Financial Accounting Standards ; Financial Technical &ulletins %8 *ronouncements issued "y the Committee on Accounting *roceduresA A' ;ealt with specific accounting and reporting pro"lems & Bere "ased on e!posure drafts and pu"lic comment letters C .riginated from congressional studies and SEC directives ; Bere the outcome of research studies and a theoretical framewor: )0 The FAS&6s standard-setting process includes3 in the correct orderA A E!posure draft3 research3 discussion paper3 Accounting Standards (pdate & +esearch3 e!posure draft3 discussion paper3 Accounting Standards (pdate %' +esearch3 discussion paper3 e!posure draft3 Accounting Standards (pdate ; ;iscussion paper3 research3 e!posure draft3 Accounting Standards (pdate )1 Bhich of the following is not a provision of the *u"lic Company Accounting +eform and ,nvestor *rotection Act of #00# -Sar"anes-.!ley/C The ActA A Changed the entity responsi"le for setting auditing standards & ,ncreased corporate e!ecutive responsi"ility for financial statements C <imited nonaudit services that can "e performed "y auditors for audit clients (' Changed the entity responsi"le for setting accounting standards )# C*As are licensed "yA A The A,C*A & The SEC C The federal government (' State governments

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

)% A firm6s comprehensive income alwaysA A ,s the same as its net income & ,s greater than its net income C ,s less than its net income (' Could "e greater than or less than net income

)) Bhich of the following has the authority to set accounting standards in the (nited StatesC A FAS& & ,+S %' SEC ; A,C*A

)0 The most li:ely important flaw leading to the demise of the A*& was the perceived lac: ofA A Confidence & Competence %' ,ndependence ; ,mportance )2 Accounting standard setting has "een characteri'ed asA A' A political process & (sing the scientific method C *ure deductive reasoning ; *ure inductive reasoning )4 The ,nternational Accounting Standards &oardA A Bas the predecessor to the ,ASC & Can overrule the FAS& when their policies disagree %' *romotes the use of high-$uality3 understanda"le glo"al accounting standards ; ?as its head$uarters in 5eneva

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

)7 The most political issue in the FAS&6s most recent deli"erations and amendments to 5AA* on "usiness com"inations wasA A' The negative effects on su"se$uent earnings of amorti'ing goodwill if firms were re$uired to use the purchase method of accounting for the com"ination & The negative effects on su"se$uent earnings of amorti'ing goodwill if firms were re$uired to use the pooling method of accounting for the com"ination C The unrealistic "alance sheet assets that would "e created if firms were re$uired to use the purchase method of accounting for the com"ination ; The unrealistic "alance sheet assets that would "e created if firms were re$uired to use the pooling method of accounting for the com"ination

)8 Bhich of the following is not a provision of the *u"lic Company Accounting +eform and ,nvestor *rotection Act of #00#C A Corporate e!ecutive accounta"ility & Auditor rotation C +etention of wor:papers (' All of the a"ove are provisions of the Act 00 Bhen a registrant company su"mits its annual filing to the SEC3 it usesA A Form 10-A &' Form 10-K C Form 10-E ; Form S-1 01 The primary professional organi'ation for those accountants wor:ing in industry is theA A AAA & A,C*A C ,,A (' ,9A 0# The primary historical reason for the FAS& reversing its positions when political pressures occur isA A The cost of gathering data was prohi"itive & The difficulties in measurement were too great C They have no authority in such situations (' The SEC did not support the FAS& position 0% The most recent e!ample of the political process at wor: in standard setting is the heated de"ate that occurred on the issue ofA A *ension plan accounting & Accounting for posteretirement "enefits other than pensions %' Accounting for "usiness com"inations ; Accounting for stoc:-"ased compensation
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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

0) The recognition of which of the following e!penses e!emplifies the application of the matching principleC A *resident6s salary & +esearch and development %' Cost of goods sold ; Advertising 00 The FAS&6s conceptual framewor:6s $ualitative characteristics of accounting information includeA A ?istorical cost & +eali'ation %' Faithful representation ; Full disclosure 02 The FAS&6s conceptual framewor:6s $ualitative characteristics of accounting information includeA A Full disclosure &' +elevance C 5oing concern ; ?istorical cost 04 The conceptual framewor:6s $ualitative characteristic of relevance includesA A' *redictive value & >erifia"ility C Completeness ; =eutrality 07 The conceptual framewor:6s $ualitative characteristic of faithful representation includesA A *redictive value &' =eutrality C Confirmatory value ; Timeliness

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

08 The conceptual framewor:6s recognition and measurement concepts recogni'e which of the following as an assumption3 rather than a principleC A' 5oing concern & ?istorical cost C Full disclosure ; +eali'ation 20 The conceptual framewor:6s recognition and measurement concepts recogni'e which of the following as a principle3 rather than an assumptionC A *eriodicity & 9onetary unit C Conservatism (' Full disclosure 21 *hase A of the new conceptual framewor: focuses onA A' ."1ective and $ualitative characteristics & *resentation and disclosure C +ecognition and measurement ; Elements of financial statements 2# The primary o"1ective of financial accounting information is to provide useful information toA A 9anagement & Capital providers C +egulators (' =one of the a"ove 2% SFAC No.5 focuses onA A ."1ectives of financial reporting & Eualitative characteristics of accounting information %' +ecognition and measurement concepts in accounting ; Elements of financial statements 2) The main issue in the de"ate over accounting for employee stoc: options wasA A Bhich employees should receive options &' The amount of compensation e!pense that a company should recogni'e C ?ow many options should "e granted to :ey e!ecutives ; The ta! conse$uences of employee stoc: options

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

20 =et income e$ualsA A Assets minus lia"ilities & +evenues minus cost of goods sold %' +evenues minus e!penses ; Cash receipts minus cash payments 22 Enhancing $ualitative characteristics of accounting information include each of the following e!ceptA A Timeliness &' 9ateriality C Compara"ility ; >erifia"ility 24 The enhancing $ualitative characteristic of understanda"ility means that information should "e understood "yA A Those who are e!perts in the interpretation of financial information &' Those who have a reasona"le understanding of "usiness and economic activities C Financial analysts ; C*As 27 Fundamental $ualitative characteristics of accounting information areA A +elevance and compara"ility & Compara"ility and consistency %' Faithful representation and relevance ; =eutrality and consistency 28 Enhancing $ualitative characteristics of accounting information includeA A +elevance and compara"ility &' Compara"ility and timeliness C (nderstanda"ility and relevance ; =eutrality and consistency 40 5ains areA A ,nflows from selling a product or service to a customer & ,ncreases in e$uity resulting from transfers of assets to the company from owners %' ,ncreases in e$uity from peripheral transactions of an entity ; =one of the a"ove

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

41 Bhen there is agreement "etween a measure or description and the phenomenon it purports to represent3 information possesses which characteristicC A >erifia"ility & *redictive value %' Faithful representation ; Timeliness 4# Surefeet Corporation changed its inventory valuation method Bhich characteristic is 1eopardi'ed "y this changeC A Compara"ility & +epresentational faithfulness %' Consistency ; Feed"ac: value 4% .f the following3 the most important o"1ective for financial reporting is to provide information useful forA A' 9a:ing decisions & ;etermining ta!a"le income C *roviding accounta"ility ; ,ncreasing future profits

4) ,ndependent auditors e!press an opinion on theA A' Fairness of financial statements & Accuracy of financial statements C Soundness of a company6s future ; Euality of a company6s management 40 Constraints on $ualitative characteristics of accounting information includeA A Timeliness & 5oing concern C =eutrality (' 9ateriality 42 Elements of financial statements do not includeA A' 9onetary unit & ,nvestments "y owners C Comprehensive income ; <osses

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

44 According to the conceptual framewor:3 verifia"ility impliesA A <egal evidence & <ogic %' Consensus ; <egal verdict 47 <and was ac$uired in #011 for a future "uilding site at a cost of F)03000 The assessed valuation for ta! purposes is F#430003 a $ualified appraiser placed its value at F)730003 and a recent firm offer for the land was for a cash payment of F)23000 The land should "e reported in the financial statements atA A' F)03000 & F#43000 C F)23000 ; F)73000 48 9altec Corporation has started placing its $uarterly financial statements on its we" page3 there"y reducing "y ten days the time to get information to investors and creditors The $ualitative concept improved isA A Compara"ility & Consistency %' Timeliness ; Faithful representation 70 +ecogni'ing e!pected losses immediately3 "ut deferring e!pected gains3 is an e!ample ofA A 9ateriality &' Conservatism C Cost effectiveness ; Timeliness 71 Change in e$uity from nonowner sources isA A' Comprehensive income & +evenues C E!penses ; 5ains and losses 7# The assumption that in the a"sence of contrary information a "usiness entity will continue indefinitely is theA A *eriodicity assumption & Entity assumption %' 5oing concern assumption ; ?istorical cost assumption

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

7% Bhich of the following Statements of Financial Accounting Concepts defines the 10 elements of financial statementsC A SFAC 4 & SFAC 3 C SFAC 5 (' SFAC 6 7) The possi"ility that the capital mar:ets6 focus on periodic profits may tempt a company6s management to "end or even "rea: accounting rules to inflate reported net income is an e!ample ofA A' An ethical dilemma & An accounting theory issue C A technical accounting issue ; =one of the a"ove is correct 70 .ne of the elements that many "elieve distinguishes a profession from other occupations is the acceptance "y its mem"ers of a responsi"ility for the interests of those it serves3 often articulated inA A ,ts conceptual framewor: &' ,ts code of ethics C Federal laws ; State laws 72 *rimecoat Corporation could disseminate its annual financial statements two days earlier if it shifted su"stantial human resources from other operations to the annual report pro1ect 9anagement decided the value of the earlier report was not worth the added commitment of resources The concept demonstrated isA A Timeliness & 9ateriality C +elevance (' Cost effectiveness

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

74 9ega <oan Company has very stringent credit re$uirements and3 accordingly3 has negligi"le losses from uncollecti"le accounts The company6s independent accountants did not protest when3 contrary to 5AA*3 the company recorded "ad de"t e!pense only when specific accounts were determined to "e uncollecti"le3 rather than use an allowance for uncollecti"le accounts The concept demonstrated isA A Compara"ility & Faithful representation C Cost effectiveness (' 9ateriality

77 An important argument in support of historical cost information isA A +elevance & *redictive $uality for future cash flows C 9ateriality (' >erifia"ility 78 ,f a company has gone "an:rupt3 its financial statements li:ely violateA A The matching principle & The reali'ation principle C The sta"le monetary unit assumption (' The going concern assumption

80 +evenue should not "e recogni'ed untilA A' The earnings process is complete and collection is reasona"ly assured & Contracts have "een signed and payment has "een received C Bor: has "een performed and customer has "een "illed ; Collection has "een made and warrantees have e!pired

81 Bhich of the following is not an identified valuation techni$ue in 5AA* regarding fair value measurementC A Cost approach & 9ar:et approach %' Cost-"enefit approach ; ,ncome approach

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

8# ;isclosure notes to a company6s financial statementsA A Are relatively unimportant facts that don6t "elong in the "asic financial statements & ;ocument the source of financial statement facts3 li:e literary footnotes %' Are an integral part of a company6s financial statements ; Are irrelevant facts that are immaterial in amount 8% Bhich of the following "est demonstrates the full disclosure principleC A The multi-step income statement & The auditors6 report C The company6s ta! return (' ;isclosure notes to financial statements 8) Four different competent accountants independently agree on the amount and method of reporting an economic event The concept demonstrated isA A +elia"ility & Compara"ility C Completeness (' >erifia"ility 80 The matching principle isA A A valuation method &' An e!pense recognition accounting principle C A cash "asis reporting principle ; An asset classification procedure 82 To meet the needs of full disclosure3 companies use supplemental information3 includingA A *arenthetical comments or modifying comments placed on the face of the financial statements & ;isclosure notes conveying additional insights a"out company operations3 accounting principles3 contractual agreements3 and pending litigation C Supplemental financial statements that report more detailed information than is shown in the primary financial statements (' All of the a"ove are correct

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

84 Ford 9otor Company purchases services from suppliers on account and sells its products to distri"utors on short-term credit As a result3 do each of these events affect net income faster than they affect net operating cash flowsC

A' .ption a & .ption " C .ption c ; .ption d

Essa) Questions

Alpaca Corporation had revenues of F#003000 in its first year of operations They have not collected on F#03000 of their sales3 and still owe F#03000 on F403000 of merchandise they purchased The company had no inventory on hand at the end of the year The company paid F103000 in salaries .wners invested F#03000 in the "usiness and F#03000 was "orrowed on a five-year note The company paid F#3000 in interest that was the amount owed for the year3 and paid F23000 for a two-year insurance policy on the first day of "usiness Alpaca has an effective income ta! rate of )0G

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

87 Compute net income for the first year for Alpaca Corporation

88 Compute the cash "alance at the end of the first year for Alpaca Corporation

Tri Fecta3 a partnership3 had revenues of F%203000 in its first year of operations The partnership has not collected on F%03000 of its sales3 and still owes F)03000 on F1003000 of merchandise they purchased There was no inventory on hand at the end of the year The partnership paid F#03000 in salaries The partners invested F)03000 in the "usiness and F#03000 was "orrowed on a five-year note The partnership paid F%3000 in interest that was the amount owed for the year and paid F73000 for a two-year insurance policy on the first day of "usiness

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

100 Compute net income for the first year for Tri Fecta

101 Compute the cash "alance at the end of the first year for Tri Fecta

The following information -F in millions/ comes from a recent annual report of Ama'on com3 ,nc A

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

10# Compute Ama'on6s "alance in cash at the "eginning of the year &eginning "alance in Cash H =et increase in Cash I Ending "alance in Cash Therefore3 "eginning "alance in Cash I Ending "alance in Cash - =et increase in Cash I F130## - 8 I F1301%

10% Compute Ama'on6s total lia"ilities at the end of the year Total assets I Total lia"ilities H Total Stoc:holders6 e$uity Therefore3 Total lia"ilities I Total assets - Total Stoc:holders6 e$uity I F)3%2% - )%1 I F%38%#

10) Compute cost of goods sold for the year 5ross profit I =et sales - Cost of goods sold Therefore3 Cost of goods sold I =et sales - 5ross profit I F103411 - #3)02 I F73#00

100 Compute the income "efore income ta! for Ama'on =et income I 5ross profit - .perating e!penses H .ther income -e!pense/3 net I F#3)02 - #3024 H -1#/ I F%44

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

102 Compare net income -loss/ for the year to net cash flow from operating activities Bhy are these amounts differentC &riefly e!plain These amounts are different "ecause of the differences "etween cash and accrual accounting As opposed to cash flows from operations3 net income includes "oth revenues and e!penses the timing of which differs from the timing of certain cash receipts and payments E!amples would "e credit sales in which the revenues are recorded "efore the collection of cash and cost of goods sold in which the e!pense often is recorded later than the cash payment to the supplier for the merchandise

104 For each of the following situations3 state whether you agree or disagree with the financial reporting practice employed3 and "riefly e!plain the reason for your answer 1 Cantor Corporation6s accountant increased the "oo: value of a patent from its original cost of F1 million to its recently appraised value of F2 million # Stanton Corporation paid for the personal travel of its chief financial officer and charged travel e!pense % At the end of its #011 fiscal year3 ;ower3 ,nc received an order from a customer for F203000 The merchandise will ship early in #01# &ecause the sale was made to a long-time customer and the invoice was paid in #0113 the controller recorded the sale in #011 ) ,n the middle of its #011 fiscal year3 Sanguinetti3 ,nc paid F1#3000 to its insurance company for one-year comprehensive insurance coverage Sanguinetti recorded the entire e!penditure as an e!pense in #011 0 The Churchill *harmaceutical Company included a note in its financial statements that descri"ed a pending lawsuit against the company 2 The ;aily Corporation3 a company whose securities are pu"licly traded3 prepares monthly3 $uarterly3 and annual financial statement for internal use "ut disseminates to e!ternal users only the annual financial statements 1 # % ) 0 2 ;isagree J This is a violation of the historical cost -original transaction value/ principle ;isagree J This is a violation of the economic entity assumption ;isagree J This is a violation of the reali'ation -revenue recognition/ principle ;isagree J This is a violation of the matching principle Agree J The company is conforming to the full disclosure principle ;isagree J This is a violation of the periodicity assumption

The following answers point out the :ey phrases that should appear in students6 answers They are not intended to "e e!amples of complete student responses ,t might "e helpful to provide detailed instructions to students on how "rief or in-depth you want their answers to "e

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

107 ,dentify or define the following termsA a economic entity3 " going concern Economic entity - All economic events can "e identified with a particular economic entity 5oing concern- ,n the a"sence of information to the contrary3 it is anticipated that a "usiness entity will continue to operate indefinitely

108 <ist the four financial statements most fre$uently provided to e!ternal users &alance sheet3 ,ncome statement3 Statement of cash flows3 Statement of shareholders6 e$uity

110 E!plain and show an e!ample of how the FAS&6s conceptual framewor: is needed in formulating standards on controversial topics There are many possi"le e!amples here For e!ample3 in de"ating accounting for stoc:-"ased compensation3 the FAS&6s conceptual framewor: e!plains the rationale for treating stoc: options as an e!pense &y relating the accounting for such compensation to the purpose of financial statements and their $ualitative characteristics3 the FAS& can defend its positions without the "ias inherent in such controversial issues

111 Bhat is the SEC and how is it involved with accounting standard settingC The Securities and E!change Commission is a federal agency that has the authority to set accounting standards ?owever3 the SEC has always delegated the tas: to a private sector "ody3 such as the current FAS&

11# Bhat is the E,TF and what is its purposeC The Emerging ,ssues Tas: Force -E,TF/ acts as a filter for the FAS& ,t includes 10 individuals from pu"lic accounting and private industry along with a representative from the FAS& and an SEC o"server The tas: force focuses on emerging issues and attempts to reach a consensus3 speeding up the standard-setting process

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

11% Accounting standard setting has "een characteri'ed as a political process ;iscuss this proposition giving an e!ample Changes in 5AA* can have significant differential effects on companies3 investors3 creditors3 and other interest groups The FAS& must gauge the economic conse$uences of a change in accounting standards The process "y which financial accounting standards are created includes pu"lic comment and sometimes hearings (ltimately3 a vote must "e ta:en to pass a proposed change in 5AA* Accounting for stoc:-"ased compensations -options/ and postretirement health care "enefits are e!amples where accounting practices have "een affected "y political influences on 5AA*

11) Bhat are the :ey provisions of the *u"lic Company Accounting +eform and ,nvestor *rotection -Sar"anes-.!ley/ Act of #00#C The act provides for the regulation of auditors and the types of services they furnish to clients3 increases accounta"ility of corporate e!ecutives3 addresses conflicts of interest for auditors and securities analysts3 and re$uires that companies document and assess their internal controls3 that auditors e!press an opinion on management6s assessment of internal controls3 and re$uires auditors to e!press their own opinion on company internal controls

110 ?ow does the value of an audit affect financial statementsC .utside auditors add credi"ility to financial statements3 increasing the confidence of capital mar:et participants who rely on financial statements in ma:ing investment and credit decisions and recommendations

112 Bhat provisions did the *u"lic Company Accounting +eform and ,nvestor *rotection -Sar"anes-.!ley/ Act of #00# ma:e for performance of non-audit services "y an audit firmC The law ma:es it unlawful for the auditors of pu"lic companies to perform a variety of nonaudit services for audit clients *rohi"ited services include "oo::eeping3 internal audit outsourcing3 appraisal or valuation services3 and various other consulting services .ther nonaudit services3 including ta! services3 re$uire pre-approval "y the audit committee of the company "eing audited

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

114 &riefly descri"e the materiality constraint 9ateriality - ,nformation is material if it can have an effect on a decision made "y a user ,f an item is not material3 5AA* need not "e followed For e!ample3 if a large corporation purchased a water cooler for one of its common areas for F1#03 the amount could "e e!pensed rather than recorded as an asset even though the cooler will "e useful for several years 9ateriality is a 1udgment call 9ateriality is concerned with "oth the dollar amount of an item and@or the nature of an item ,t would pro"a"ly "e material if 9icrosoft received F130003000 in "ri"es from the Chinese for its technology A F130003000 write-off of old e$uipment would pro"a"ly "e immaterial for 9icrosoft

117 5ive an e!ample of a violation of the sta"le monetary unit assumption ?ow would it affect the $uality of financial statement informationC ,n a place or time in which a country e!periences severe inflation3 this would violate the assumption that dollar amounts are constantly valued This would limit the usefulness of adding num"ers in financial statements3 "ecause -for instance/ costs at different times are not compara"le without ad1usting for changes in purchasing power

118 ,dentify or define the following termsA a periodicity3 " monetary unit *eriodicity - The life of a company can "e divided into artificial time periods to provide timely information to e!ternal users 9onetary unit- ,n the ( S 3 financial statement elements should "e measured in terms of the ( S dollar ,t assumes that the value of a dollar is sta"le over time

1#0 ,dentify or define the following termsA a historical cost3 " reali'ation ?istorical cost - Asset and lia"ility measurements should "e "ased on the amount given or received in an e!change transaction +eali'ation - +evenue should "e recogni'ed only after the earnings process is virtually complete and there is reasona"le certainty of collecting the asset to "e received from the customer

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

1#1 ?ow does 5AA* define fair valueC Fair value is defined as the price that would "e received to sell assets or paid to transfer a lia"ility in an orderly transaction "etween mar:et participants at the measurement date

1## Accounting standards have developed over time to reflect changes in the "usiness world as well as changes in our a"ility to account for such changes (sing the e!ample of mar:ing assets and lia"ilities to their fair value3 e!plain why you would e!pect accounting standards to change ?istorically3 financial accounting relied on transaction amounts -historical cost/ as the fundamental measurement approach for reporting assets and lia"ilities As mar:ets have matured3 it is more relevant and feasi"le to report some assets and lia"ilities at their fair values3 particularly if such items have a ready mar:et that is active

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