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Centre of Information and

Technology

Advance Financial Accounting (M.Com - Semester
1)

Introduction to Financial Reporting
1. How does the concept of consistency aid in the analysis of financial statements? What type of
accounting disclosure is required if this concept is not applied?
ANS: Consistency allows for the same accounting principle from period to period. A change in
principle requires statement disclosure.
2. The president of your firm, Lesky and Lesky, has little background in accounting. Today, he walked
into your office and said, “A year ago we bought a piece of land for $100,000. This year, inflation has
driven prices up by 6%, and an appraiser just told us we could easily resell the land for $115,000. Yet
our balance sheet still shows it at $100,000. It should be valued at $115,000. That’s what it’s worth.
Or, at a minimum, at $106,000.” Respond to this statement with specific reference to accounting
principles applicable in this situation.
ANS: The concept of historical cost determines the balance sheet valuation of land. The realization
concept requires that a transaction has occurred for the profit to be recognized.
3. Identify the accounting principle(s) applicable to each of the following situations:
a. Tim Roberts owns a bar and a rental apartment and operates a consulting service. He has
separate financial statements for each.
b. An advance collection for magazine subscriptions is reported as a liability titled Unearned
Subscriptions.
c. Purchases for office or store equipment for less than $25 are entered in Miscellaneous Expense.
d. A company uses the lower of cost or market for valuation of its inventory.
e. Partially completed television sets are carried at the sum of the cost incurred to date.
f. Land purchased 15 years ago for $40,500 is now worth $346,000. It is still carried on the books at
$40,500.
g. Zero Corporation is being sued for $1,000,000 for breach of contract. Its lawyers believe that the
damages will be minimal. Zero reports the possible loss in a note.
ANS:
a. Entity
e. Historical cost
b. Realization
f. Historical cost
c. Materiality
g. Disclosure
d. Conservatism
4. A corporation like General Motors has many owners (stockholders). Which concept enables the
accountant to account for transactions of General Motors, separate and distinct from the personal
transactions of the owners of General Motors?
ANS: Entity concept
5. Zebra Company has incurred substantial financial losses in recent years. Because of its financial
condition, the ability of the company to keep operating is in question. Management prepares a set of
financial statements that conform to generally accepted accounting principles. Comment on the use
of GAAP under these conditions.
Compiled By: M.BILAL KAMRANPage 1

But it is not necessary that the statements be completely accurate in order for them to be meaningful. short of its complete life span. 8. inaccuracies of accounting for the entity. Yes. ANS: When money does not hold a stable value. 7. technology. 9.Semester 1) ANS: Generally accepted accounting principles do not apply when a firm does not appear to be a going concern. the statements are inaccurate and are. In this case the liquidation values are the appropriate figures. The assumption is made that the entity can be accounted for reasonably accurately for a particular period of time. which indicate the period of time included in the financial statements: ANS: a. Countries have had problems with the stability of their money. it loses usefulness as the standard for measuring financial transactions. Briefly describe the problem caused for financial statements when money does not hold a stable value. therefore. Can an accurate adjustment for inflation be made to the statements? Can a reasonable adjustment to the statements be made? Discuss. Comment. Which standard of measure is the best for measuring financial transactions? ANS: Money 10. Compiled By: M. c.BILAL KAMRANPage 2 . A reasonable adjustment to the statements can be made for inflation. The items that are included in the index must be representative and the price of items change because of various factors. Describe the following terms. such as quality. ANS: 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. not a very meaningful tool to determine the profits or losses of an entity or the financial position of an entity. and inflation. are accepted. The statements are considered to be meaningful because material inaccuracies are not acceptable. 6.Centre of Information and Technology Advance Financial Accounting (M.Com . Calendar year: The accounting time period is ended on December 31. 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. ANS: With the time period assumption. Discuss the necessity of having completely accurate statements. In other words. To the extent that money does not remain stable. the financial statements can lose much of their significance. the decision is made to accept some inaccuracy because of incomplete information about the future in exchange for more timely reporting. There is a problem with determining the index in order to adjust the statements. Fiscal year: A twelve-month accounting period that ends at the end of a month other than December 31. ANS: No. Natural business year: A year that ends when operations are at a low ebb for the year. Comment on whether this is true. Because of assumptions and estimates that go into the preparation of financial statements. In some countries where inflation has been material. 11. b. an effort has been made to retain the significance of money as a measuring unit by adjusting the financial statements by an inflation factor.

13. ANS: 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. This is done based upon the concept of conservatism. 16. List and discuss the other methods reviewed in this chapter. The conservatism concept can only be applied where there are alternative measurements and each of these alternative measurements has reasonable support. inventory that has a market value below the historical cost should be written down in order to recognize a loss. provided it makes full disclosure? ANS: If the entity can justify the use of an alternative accounting method on the basis that it is preferable. Under what circumstances can an entity change its accounting methods. Is this statement true or false? Discuss.BILAL KAMRANPage 3 . Comment.Com . 17. the matching concept is difficult to apply. The consistency concept requires the entity to give the same treatment to comparable transactions from period to period. 15. 14. What do accountants often do under these circumstances? ANS: It is difficult to apply the matching concept when there is no direct connection between the cost and revenue. Usually this is a judgment decision for the accountant to make. For some costs. There are other acceptable methods of recognizing revenue when the point of sale is not acceptable. Because of the complexity of Compiled By: M. ANS: The accounting reports must disclose all facts that may influence the judgment of an informed reader.Centre of Information and Technology Advance Financial Accounting (M. The matching concept involves the determination of when to recognize the costs associated with the revenue that is being recognized. Losses that can be reasonably anticipated should be taken in order to reflect the least favorable effect on net income of the current period. Under these circumstances. An arbitrary write-off of inventory can be justified under the conservatism concept. such as administrative costs. and indicate when they can be used. 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 from a project.Semester 1) 12. then the change can be made. An arbitrary write-off of inventory cannot be justified under the conservatism concept. ANS: False. Comment on when it is difficult to apply the matching concept. Inventory that has a market value below the historical cost should be written down in order to recognize a loss. Receipt of cash: This method should only be used when the prospects of collection are especially doubtful at the time of sale. ANS: Yes. Discuss why the concept of full disclosure is difficult to apply. accountants often charge off the cost in the period incurred in order to be conservative.

Generally accepted accounting principles have substantial authoritative support. but financial statements cannot be completely prepared based upon objective data. An example would be the loss of a major customer. It is proper to handle immaterial items in the most economical. The concepts of materiality allow the accountant to handle immaterial items in the most economical and expedient manner possible. Comment. ANS: There is a preference for the use of objectivity in the preparation of financial statements. 18. 20. 21. Only under limited circumstances can the entity use the cash basis. ANS: Events that fall outside of the financial transactions of the entity are not recorded. 22. but the accounting profession is making an effort to eliminate particular industry practices that do not conform to the normal generally accepted accounting principles. generally accepted accounting principles do not apply. The same generally accepted accounting principles apply to all companies. expedient manner possible.Centre of Information and Technology Advance Financial Accounting (M. Discuss. ANS: True. The ultimate responsibility is with the accountant to prove that generally acceptable accounting principles have been followed. Some industry practices lead to accounting reports that do not conform to the general theory that underlies accounting. 19.BILAL KAMRANPage 4 . These reports are considered to be acceptable. In other words. the accountant must be familiar with acceptable sources to refer to in order to decide whether any particular accounting principle has substantial authoritative support.Semester 1) many businesses and the increased expectations of the public. 24.Com . Comment. Indicate the problem with determining substantial authoritative support. ANS: The entity must usually use the accrual basis of accounting. ANS: Some industry practices lead to accounting reports that do not conform to generally accepted accounting principles. ANS: This is a true statement. The accounting profession is making an effort to reduce or eliminate specific industry practices. the full disclosure concept has become one of the most difficult concepts for the accountant to apply. therefore. including a concept that justifies your answer. No estimates or subjectivity is allowed in the preparation of financial statements. Comment and give an example. Comment. An entity may choose between the use of the accrual basis of accounting and the cash basis. ANS: There is no one source or list of accounting principles that has substantial authoritative support. Many important events that influence the prospect for the entity are not recorded in the financial records. 23. Compiled By: M. estimates must be made in many situations. Comment.

Revenue should not be recorded for the savings between the cost of $50. 32.000. Explain the matching principle.000? ANS: a. government body has the legal power to determine generally accepted accounting principles? ANS: The Securities and Exchange Commission (SEC). the dollar has not been stable in terms of purchasing power and.000. 31. Revenue comes from selling.Com . b. At what amount should the building be recorded? b. Comment. What concept supports this policy? ANS: The materiality concept supports this policy.S.Centre of Information and Technology Advance Financial Accounting (M.000 and the bid of $60. Financial accounting is designed to measure directly the value of a business enterprise. Which U.000 and the bid of $60. How is the matching principle related to the realization concept? ANS: The matching principle deals with the costs to be matched against revenue. The combination of revenue and costs determine income. 30. Should revenue be recorded for the savings between the cost of $50.000. Briefly explain the term generally accepted accounting principles. At which point is revenue from sales on account (credit sales) commonly recognized? ANS: At the point of sale 27. What is the basic problem with the monetary assumption when there has been significant inflation? ANS: 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. 28. The building should be recorded at cost.Semester 1) 25.BILAL KAMRANPage 5 . 26. which is $50. 33. therefore. The realization concept has to do with the determination of revenue. A local contractor had submitted a bid to construct it for $60. dollars are being compared that are not of the same purchasing power. When there has been inflation.000. Would an accountant record the personal assets and liabilities of the owners in the accounts of the business? Explain. ANS: The term "generally accepted accounting principles" is used to refer to accounting principles that have substantial authoritative support. not from purchasing. a. 29. Elliott Company constructed a building at a cost of $50. Compiled By: M. ANS: The separate entity concept directs that personal transactions of the owners not be recorded on the books of the entity. Dexter Company charges to expense all equipment that costs $25 or less.

Decision usefulness e. The cash basis recognizes revenue when the cash is received and expenses when payments are made.Com . to be relevant. but the information it provides may be helpful to those who wish to estimate its value. 2. ANS: According to Concepts Statement No. information must be timely and it must have predictive value or feedback value or both. Current market value 4. Comment on what is meant by relevance and reliability. Concepts Statement No. 35. Required Place the appropriate letter identifying each quality on the line in front of the statement or phrase describing the quality. 34. Comment. The cash basis recognizes cash receipts as revenue and cash payments as expenses.Centre of Information and Technology Advance Financial Accounting (M. The cash basis does not reasonably indicate when the revenue was earned and when the cost should be recognized. It is not important to know when cash is received and when payment is made. List these measurement attributes ANS: 1. Present value 36. According to SFAC No. There are five different measurement attributes currently used in practice. Following is a list of some of these qualities. P 1-1. 38. c. Net realizable value 5. ANS: The accrual basis income statement recognizes revenue when it is realized (realization concept) and expenses recognized when they are incurred (matching concept). relevance and reliability are the two primary qualities that make accounting information useful for decision making.BILAL KAMRANPage 6 . Relevance a. Usually the cash basis does not indicate when the revenue was earned and when the cost should be recognized. 1 indicates that financial accounting is not designed to measure directly the value of a business enterprise. timeliness Compiled By: M. To be reliable. Comment. Current cost 3. the timing of cash receipts and cash payments can have a bearing on a company's ability to pay bills on time. 2. Predictive value. 2 indicates several qualitative characteristics of useful accounting information.Semester 1) ANS: Financial accounting is not designed to measure directly the value of a business enterprise. Historical cost 2. ANS: When cash is received and when payment is made is important. ANS: True. as well as a list of statements and phrases describing the qualities. Benefits > costs d. FASB Statement of Concepts No. Reliability b. Briefly explain the difference between an accrual basis income statement and a cash basis income statement. For example. 37. information must have representational faithfulness and it must be verifiable and neutral. feedback value.

These are the ingredients needed to ensure that the information is relevant.Com . Time period o. Verifiability k. (e) 8. Going concern or continuity b. Materiality g. Includes consistency and interacts with relevance and reliability to contribute to the usefulness of information. reliability 1. Transaction approach Compiled By: M. (b) 2. (b) 4. Verifiability. Materiality i. (i) 7.Semester 1) representational g. (d) 6. faithfulness neutrality. Following is a list of these underlying considerations. (f) 9. Conservatism d. Realization m. Consistency l. (g) P 1-2. These are the two primary qualities that make accounting information useful for decision making. Required Place the appropriate letter identifying each quality on the line in front of the statement describing the quality. Full disclosure f. Comparability h. A quality requiring that the information be timely and that it also have predictive value. (c) 5. Historical cost n. A quality requiring that the information have representational faithfulness and that it be verifiable and neutral. Advance Financial Accounting (M.Centre of Information and Technology f. Matching e. a. These are the ingredients needed to ensure that the information is reliable. as well as a list of statements describing them. there would be no benefits from information to set against its cost. Business entity . or feedback value. Certain underlying considerations have had an important impact on the development of generally accepted accounting principles. Relevance. Industry practices j. Monetary unit c. Constraint that guides the threshold for recognition.BILAL KAMRANPage 7 h. or both. Pervasive constraint imposed upon financial accounting information. Accrual basis i. (a) 3. Without usefulness.

(c) 14. and expenses are recognized when incurred (matching concept). With this assumption. Revenue must be recognized when it is realized (realization concept). (f) 8. (b) 4. The accountant is required to adhere as closely as possible to verifiable data. The accountant records only events that affect the financial position of the entity and. (e) 7. This concept involves the relative size and importance of an item to a firm. can be reasonably determined in monetary terms. (m) 15. at the same time. Of the various values that could be used. (o) 2. The entity must give the same treatment to comparable transactions from period to period. The business for which the financial statements are prepared is separate and distinct from the owners. (i) 10. Accountants need some standard of measure to bring financial transactions together in a meaningful way. The assumption is made that the entity will remain in business for an indefinite period of time. Accounting reports must disclose all facts that may influence the judgment of an informed reader. this value has been selected because it is objective and determinable. The measurement with the least favorable effect on net income and financial position in the current period must be selected. This concept deals with when to recognize the costs that are associated with the recognized revenue. (n) . (d) 6. (q) 11. (l) 5. (k) 13. (a) 3.1. Revenue should be recognized when the earning process is virtually complete and the exchange value can be objectively determined. (h) 12. inaccuracies of accounting for the entity short of its complete life span are accepted. Some companies use accounting reports that do not conform to the general theory that underlies accounting. (j) 9.