Chap 00127

Chapter 01 - Environment and Theoretical Structure of Financial Accounting
Chapter 01
Environment and Theoretical Structure of Financial Accounting

True / False Questions

1. The primary function of financial accounting is to provide relevant financial information to
parties external to usiness enterprises.
True False

!. Accrual accounting attempts to measure revenues and expenses that occurred during
accounting periods so they e"ual net operating cash flo#.
True False

$. The FAS% is currently the pulic sector organi&ation responsile for setting accounting
standards in the '.S.
True False

(. The )ulic *eform and +nvestor )rotection Act of !00! ,Saranes--xley. changed the
entity responsile for setting auditing standards in the 'nited States.
True False

/. A rules-ased approach to standard setting stresses professional 0udgment as opposed to
follo#ing a list of rules.
True False

1. 'nder federal securities la#s2 the SEC has the authority to set accounting standards in the
'.S.
True False

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3. The primary responsiility for properly applying 4AA) #hen communicating #ith
investors and creditors through financial statements lies #ith a firm5s auditors.
True False

6. Auditors play an important role in the resource allocation process y adding crediility to
financial statements.
True False

7. 8ateriality can e affected y the dollar amount of an item2 the nature of the item2 or oth.
True False

10. Conservatism is a desired "ualitative characteristic of accounting information.
True False

11. E"uity is a residual amount representing the o#ner5s interest in the assets of the usiness.
True False

1!. *evenues are inflo#s or other enhancements of assets or settlements of liailities from
activities that constitute the entity5s ongoing operations.
True False

1$. 4ains or losses result2 respectively2 from the disposition of usiness assets for greater
than2 or less than2 their oo9 values.
True False

1(. Comprehensive income is another term for net income.
True False

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1/. :etermining fair value y calculating the present value of future cash flo#s is a level 1
type of input.
True False

11. The FAS%5s frame#or9 for measuring fair value doesn5t change the situations in #hich
fair value is used under current 4AA).
True False

Matching Questions

13. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
of the terms. 8atch each phrase #ith the correct term y placing the letter designating the est
term in the space provided y the phrase.
1. )redictive value +nformation is useful in pro0ecting cash flo#s. <<<<
!. *elevance )ertinent to the decision at hand. <<<<
$. :istriution to o#ners +nformation is availale prior to the decision. <<<<
(. Confirmatory value :ecrease in e"uity due to transfers to o#ners. <<<<
/. Timeliness +nformation confirms expectations. <<<<

1. 4ain
Along #ith relevance2 a fundamental decision-
specific "uality. <<<<
!. 8ateriality
*esults if an asset is sold for more than oo9
value. <<<<
$. Completeness
+nformation contains all information necessary
for faithful representation. <<<<
(. Comprehensive
income
The change in e"uity from nono#ner
transactions. <<<<
/. Faithful
representation
Concerns the decision-ma9ing impact of oth the
amount and nature of an item. <<<<

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of the terms. 8atch each phrase #ith the correct term #ith their phrases y placing the letter
designating the est term in the space provided y the phrase.
1. =eutrality +mportant in analysis et#een firms. <<<<
!. Comparaility Accounting information should e uniased. <<<<
$. Consistency
The process of including data in financial
statements. <<<<
(. Cost
effectiveness Applying the same accounting practices over time. <<<<
/. *ecognition
Considers the value of using information relative to
cost of providing it. <<<<

!0. ;isted elo# are ten terms are follo#ed y a list of phrases that descrie or characteri&e
five of the terms. 8atch each phrase #ith the correct term y placing the letter designating the
est term in the space provided y the phrase.
1. 8onetary unit
assumption +mplies consensus among different oservers. <<<<
!. >erifiaility
Assumes all transactions can e identified #ith
a particular entity. <<<<
$. Economic entity
assumption
Assumes an entity #ill continue to operate
indefinitely. <<<<
(. 4oing concern
assumption
*e"uires reporting the financial life of an
entity in discrete time frames. <<<<
/. )eriodicity
assumption +gnores the possiility of inflation. <<<<

!1. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. ?istorical cost
principle %asis of measurement for fixed assets. <<<<
!. 8ateriality
*ecognition of revenue only after certain
criteria are satisfied. <<<<
$. 8atching principle 4uide to expense recognition. <<<<
(. Full-disclosure
principle
*eporting of all information that could affect
decisions. <<<<
/. *eali&ation principle
Application of 4AA) sometimes avoided under
this constraint. <<<<

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!!. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. Financial Accounting
Standards %oard
+t is a practical 0ustification for choosing
among alternative accounting methods. <<<<
!. Accounting )rinciples
%oard +t estalished 4AA) efore the FAS%. <<<<
$. Conservatism
+ts EITF Issues are 4AA) #hen entered in
the Accounting Standards Codification. <<<<
(. A+C)A
+t has the authority to set '.S. accounting
standards. <<<<
/. Securities and Exchange
Commission
+t is the national organi&ation for C)As in
the '.S. <<<<

!$. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. Expenses =et assets. <<<<
!. E"uity -utflo#s of resources to generate revenues. <<<<
$. :istriutions to
o#ners Cash dividends. <<<<
(. +nvestments y
o#ners
Claims of creditors against the assets of a
usiness. <<<<
/. ;iailities
Transfers of resources in exchange for common
and preferred stoc9. <<<<

!(. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. ;osses =et outflo#s from peripheral transactions. <<<<
!. Assets
+ncreases in e"uity from the sale of goods
and@or services. <<<<
$. *evenues
value. <<<<
(. Comprehensive
income
All changes in e"uity except o#ner
transactions. <<<<
/. 4ains
)roale future economic enefits controlled
y an entity. <<<<

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!/. ;isted elo# are ten organi&ations follo#ed y a list of phrases that descrie or
characteri&e the organi&ations. 8atch each phrase #ith the correct organi&ation y placing the
letter designating the est term in the space provided y the phrase.
1. SEC
Estalishes auditing standards in the '.S for pulic
companies. <<<<
!. FAS%
)rimary national organi&ation of accountants #or9ing in
industry. <<<<
$. +AS% Sets accounting standards in the '.S. <<<<
(. A+C)A )rovides timely responses to financial reporting issues. <<<<
/. E+TF The FAS%5s parent organi&ation. <<<<
1. )CA-% )arent organi&ation of the +AS%. <<<<
3. +8A FAS%5s predecessor. <<<<
6. +ASC *egulates the financial reporting for pulic companies. <<<<
7. A)% =ational organi&ation of certified pulic accountants. <<<<
10. FAF Sets gloal accounting standards. <<<<

Multiple Choice Questions

!1. External decision ma9ers #ould not loo9 primarily to financial accounting information to
assist them in ma9ing decisions onA
A. 4ranting credit.
%. Capital udgeting.
C. Selecting stoc9s.
:. 8ergers and ac"uisitions.

!3. Corporations issue their shares to the investing pulic in theA

A. -ption A
%. -ption %
C. -ption C
:. -ption :

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!6. The primary focus for financial accounting information is to provide information useful
forA

A. -ption A
%. -ption %
C. -ption C
:. -ption :

!7. Bhich of the follo#ing is not true aout net operating cash flo#C
A. +t is the difference et#een cash receipts and cash disursements 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 flo#s.
C. -ver short periods of time2 it may not e indicative of long-run cash-generating aility.
:. +t is easy to understand and all information re"uired to measure it is factual.

$0. Bhich of the follo#ing groups is not among financial intermediariesC
A. 8utual fund managers
%. Financial analysts
C. C)As
:. Credit rating organi&ations

$1. Bhich of the follo#ing #as 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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$!. Bhich of the follo#ing does not apply to secondary mar9etsC
A. Transactions are important to the efficient allocation of resources in our economy.
%. =e# resources are provided #hen shares of stoc9 are sold y the corporation to the initial
o#ners.
C. Transactions help to estalish mar9et prices for additional shares that may e issued in the
future.
:. 8any investors might e un#illing to provide resources to corporations if there is no
availale mechanism for the future sale of their stoc9s and onds to others.

$$. A cause-and-effect relationship is implicit in theA
A. *eali&ation principle.
%. ?istorical cost principle.
C. 8atching principle.
:. 4oing concern assumption.

$(. The full disclosure principle re"uires a alance et#eenA
A. Comparaility and consistency.
%. *elevance and cost effectiveness.
C. *eliaility and neutrality.
:. Timeliness and predictive value.

$/. Bhich of the follo#ing groups is not among the external users for #hom financial
statements are preparedC
A. Customers
%. Suppliers
C. Employees
:. All of the aove are external users of financial statements.

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$1. +n a recent annual report2 Apple Computer reported the follo#ing in one of its disclosure
notesA DBarranty ExpenseA The Company provides currently for the estimated cost for product
#arranties at the time the related revenue is recogni&ed.D This note exemplifies Apple5s use
ofA
A. Conservatism
%. The matching principle
C. *eali&ation principle
:. Economic entity

$3. 4AA) is an areviation forA
A. 4enerally authori&ed accounting procedures.
%. 4enerally applied accounting procedures.
C. 4enerally accepted auditing practices.
:. 4enerally accepted accounting principles.

$6. The SEC issues accounting standards in the form ofA
A. Accounting *esearch %ulletins.
%. Financial *eporting *eleases.
C. Financial Accounting Standards.
:. Financial Technical %ulletins.

$7. )ronouncements issued y the Committee on Accounting )roceduresA
A. :ealt #ith specific accounting and reporting prolems.
%. Bere ased on exposure drafts and pulic comment letters.
C. -riginated from congressional studies and SEC directives.
:. Bere the outcome of research studies and a theoretical frame#or9.

(0. The FAS%5s standard-setting process includes2 in the correct orderA
A. Exposure draft2 research2 discussion paper2 Accounting Standards 'pdate.
%. *esearch2 exposure draft2 discussion paper2 Accounting Standards 'pdate.
C. *esearch2 discussion paper2 exposure draft2 Accounting Standards 'pdate.
:. :iscussion paper2 research2 exposure draft2 Accounting Standards 'pdate.

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(1. Bhich of the follo#ing is not a provision of the )ulic Company Accounting *eform and
+nvestor )rotection Act of !00! ,Saranes--xley.C The ActA
A. Changed the entity responsile for setting auditing standards.
%. +ncreased corporate executive responsiility for financial statements.
C. ;imited nonaudit services that can e performed y auditors for audit clients.
:. Changed the entity responsile for setting accounting standards.

(!. C)As are licensed yA
A. The A+C)A.
%. The SEC.
C. The federal government.
:. State governments.

($. A firm5s comprehensive income al#aysA
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 follo#ing has the authority to set accounting standards in the 'nited StatesC
A. FAS%
%. +*S
C. SEC
:. A+C)A

(/. The most li9ely important fla# leading to the demise of the A)% #as the perceived lac9
ofA
A. Confidence.
%. Competence.
C. +ndependence.
:. +mportance.

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(1. Accounting standard setting has een characteri&ed asA
A. A political process.
%. 'sing the scientific method.
C. )ure deductive reasoning.
:. )ure inductive reasoning.

(3. The +nternational Accounting Standards %oardA
A. Bas the predecessor to the +ASC.
%. Can overrule the FAS% #hen their policies disagree.
C. )romotes the use of high-"uality2 understandale gloal accounting standards.
:. ?as its head"uarters in 4eneva.

(6. The most political issue in the FAS%5s most recent delierations and amendments to
4AA) on usiness cominations #asA
A. The negative effects on suse"uent earnings of amorti&ing good#ill if firms #ere re"uired
to use the purchase method of accounting for the comination.
%. The negative effects on suse"uent earnings of amorti&ing good#ill if firms #ere re"uired
to use the pooling method of accounting for the comination.
C. The unrealistic alance sheet assets that #ould e created if firms #ere re"uired to use the
purchase method of accounting for the comination.
:. The unrealistic alance sheet assets that #ould e created if firms #ere re"uired to use the
pooling method of accounting for the comination.

+nvestor )rotection Act of !00!C
A. Corporate executive accountaility.
%. Auditor rotation.
C. *etention of #or9papers.
:. All of the aove are provisions of the Act.

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/0. Bhen a registrant company sumits its annual filing to the SEC2 it usesA
A. Form 10-A.
%. Form 10-E.
C. Form 10-F.
:. Form S-1.

/1. The primary professional organi&ation for those accountants #or9ing in industry is theA
A. AAA
%. A+C)A
C. ++A
:. +8A

/!. The primary historical reason for the FAS% reversing its positions #hen political
pressures occur isA
A. The cost of gathering data #as prohiitive.
%. The difficulties in measurement #ere too great.
C. They have no authority in such situations.
:. The SEC did not support the FAS% position.

/$. The most recent example of the political process at #or9 in standard setting is the heated
deate that occurred on the issue ofA
A. )ension plan accounting.
%. Accounting for posteretirement enefits other than pensions.
C. Accounting for usiness cominations.
:. Accounting for stoc9-ased compensation.

/(. The recognition of #hich of the follo#ing expenses exemplifies the application of the
matching principleC
A. )resident5s salary.
%. *esearch and development.
C. Cost of goods sold.
:. Advertising.

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//. The FAS%5s conceptual frame#or95s "ualitative characteristics of accounting information
includeA
A. ?istorical cost.
%. *eali&ation.
C. Faithful representation.
:. Full disclosure.

/1. The FAS%5s conceptual frame#or95s "ualitative characteristics of accounting information
includeA
A. Full disclosure.
%. *elevance.
C. 4oing concern.
:. ?istorical cost.

/3. The conceptual frame#or95s "ualitative characteristic of relevance includesA
A. )redictive value.
%. >erifiaility.
C. Completeness.
:. =eutrality.

/6. The conceptual frame#or95s "ualitative characteristic of faithful representation includesA
%. =eutrality.
C. Confirmatory value.
:. Timeliness.

/7. The conceptual frame#or95s recognition and measurement concepts recogni&e #hich of
the follo#ing as an assumption2 rather than a principleC
A. 4oing concern.
%. ?istorical cost.
C. Full disclosure.
:. *eali&ation.

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10. The conceptual frame#or95s recognition and measurement concepts recogni&e #hich of
the follo#ing as a principle2 rather than an assumptionC
A. )eriodicity.
%. 8onetary unit.
C. Conservatism.
:. Full disclosure.

11. )hase A of the ne# conceptual frame#or9 focuses onA
A. -0ective and "ualitative characteristics.
%. )resentation and disclosure.
C. *ecognition and measurement.
:. Elements of financial statements.

1!. The primary o0ective of financial accounting information is to provide useful information
toA
A. 8anagement.
%. Capital providers.
C. *egulators.
:. =one of the aove.

1$. SFAC No.5 focuses onA
A. -0ectives of financial reporting.
%. Fualitative characteristics of accounting information.
C. *ecognition and measurement concepts in accounting.

1(. The main issue in the deate over accounting for employee stoc9 options #asA
A. Bhich employees should receive options.
%. The amount of compensation expense that a company should recogni&e.
C. ?o# many options should e granted to 9ey executives.
:. The tax conse"uences of employee stoc9 options.

1-1(
1/. =et income e"ualsA
A. Assets minus liailities.
%. *evenues minus cost of goods sold.
C. *evenues minus expenses.
:. Cash receipts minus cash payments.

11. Enhancing "ualitative characteristics of accounting information include each of the
follo#ing exceptA
A. Timeliness.
%. 8ateriality.
C. Comparaility.
:. >erifiaility.

13. The enhancing "ualitative characteristic of understandaility means that information
should e understood yA
A. Those #ho are experts in the interpretation of financial information.
%. Those #ho have a reasonale understanding of usiness and economic activities.
C. Financial analysts.
:. C)As.

16. Fundamental "ualitative characteristics of accounting information areA
A. *elevance and comparaility.
%. Comparaility and consistency.
C. Faithful representation and relevance.
:. =eutrality and consistency.

17. Enhancing "ualitative characteristics of accounting information includeA
%. Comparaility and timeliness.
C. 'nderstandaility and relevance.

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30. 4ains areA
A. +nflo#s from selling a product or service to a customer.
%. +ncreases in e"uity resulting from transfers of assets to the company from o#ners.
C. +ncreases in e"uity from peripheral transactions of an entity.

31. Bhen there is agreement et#een a measure or description and the phenomenon it
purports to represent2 information possesses #hich characteristicC
A. >erifiaility.
%. )redictive value.
C. Faithful representation.
:. Timeliness.

3!. Surefeet Corporation changed its inventory valuation method. Bhich characteristic is
0eopardi&ed y this changeC
A. Comparaility.
%. *epresentational faithfulness.
C. Consistency.
:. Feedac9 value.

3$. -f the follo#ing2 the most important o0ective for financial reporting is to provide
information useful forA
A. 8a9ing decisions.
%. :etermining taxale income.
C. )roviding accountaility.
:. +ncreasing future profits.

3(. +ndependent auditors express an opinion on theA
A. Fairness of financial statements.
%. Accuracy of financial statements.
C. Soundness of a company5s future.
:. Fuality of a company5s management.

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3/. Constraints on "ualitative characteristics of accounting information includeA
A. Timeliness.
%. 4oing concern.
C. =eutrality.
:. 8ateriality.

31. Elements of financial statements do not includeA
A. 8onetary unit.
%. +nvestments y o#ners.
C. Comprehensive income.
:. ;osses.

33. According to the conceptual frame#or92 verifiaility impliesA
A. ;egal evidence.
%. ;ogic.
C. Consensus.
:. ;egal verdict.

36. ;and #as ac"uired in !011 for a future uilding site at a cost of G(02000. The assessed
valuation for tax purposes is G!320002 a "ualified appraiser placed its value at G(620002 and a
recent firm offer for the land #as for a cash payment of G(12000. The land should e reported
in the financial statements atA
A. G(02000.
%. G!32000.
C. G(12000.
:. G(62000.

37. 8altec Corporation has started placing its "uarterly financial statements on its #e page2
therey reducing y ten days the time to get information to investors and creditors. The
"ualitative concept improved isA
A. Comparaility.
%. Consistency.
C. Timeliness.
:. Faithful representation.

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60. *ecogni&ing expected losses immediately2 ut deferring expected gains2 is an example ofA
A. 8ateriality.
%. Conservatism.
C. Cost effectiveness.
:. Timeliness.

61. Change in e"uity from nono#ner sources isA
A. Comprehensive income.
%. *evenues.
C. Expenses.
:. 4ains and losses.

6!. The assumption that in the asence of contrary information a usiness entity #ill continue
indefinitely is theA
A. )eriodicity assumption.
%. Entity assumption.
C. 4oing concern assumption.
:. ?istorical cost assumption.

6$. Bhich of the follo#ing Statements of Financial Accounting Concepts defines the 10
elements of financial statementsC
A. SFAC 4
%. SFAC 3
C. SFAC 5
:. SFAC 6

6(. The possiility that the capital mar9ets5 focus on periodic profits may tempt a company5s
management to end or even rea9 accounting rules to inflate reported net income is an
example ofA
A. An ethical dilemma.
%. An accounting theory issue.
C. A technical accounting issue.
:. =one of the aove is correct.

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6/. -ne of the elements that many elieve distinguishes a profession from other occupations
is the acceptance y its memers of a responsiility for the interests of those it serves2 often
articulated inA
A. +ts conceptual frame#or9.
%. +ts code of ethics.
C. Federal la#s.
:. State la#s.

61. )rimecoat Corporation could disseminate its annual financial statements t#o days earlier
if it shifted sustantial human resources from other operations to the annual report pro0ect.
8anagement decided the value of the earlier report #as not #orth the added commitment of
resources. The concept demonstrated isA
A. Timeliness.
%. 8ateriality.
C. *elevance.
:. Cost effectiveness.

63. 8ega ;oan Company has very stringent credit re"uirements and2 accordingly2 has
negligile losses from uncollectile accounts. The company5s independent accountants did not
protest #hen2 contrary to 4AA)2 the company recorded ad det expense only #hen specific
accounts #ere determined to e uncollectile2 rather than use an allo#ance for uncollectile
accounts. The concept demonstrated isA
A. Comparaility.
%. Faithful representation.
:. 8ateriality.

66. An important argument in support of historical cost information isA
A. *elevance.
%. )redictive "uality for future cash flo#s.
C. 8ateriality.
:. >erifiaility.

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67. +f a company has gone an9rupt2 its financial statements li9ely violateA
A. The matching principle.
%. The reali&ation principle.
C. The stale monetary unit assumption.
:. The going concern assumption.

70. *evenue should not e recogni&ed untilA
A. The earnings process is complete and collection is reasonaly assured.
%. Contracts have een signed and payment has een received.
C. Bor9 has een performed and customer has een illed.
:. Collection has een made and #arrantees have expired.

71. Bhich of the follo#ing is not an identified valuation techni"ue in 4AA) regarding fair
value measurementC
A. Cost approach.
%. 8ar9et approach.
C. Cost-enefit approach.
:. +ncome approach.

7!. :isclosure notes to a company5s financial statementsA
A. Are relatively unimportant facts that don5t elong in the asic financial statements.
%. :ocument the source of financial statement facts2 li9e literary footnotes.
C. Are an integral part of a company5s financial statements.
:. Are irrelevant facts that are immaterial in amount.

7$. Bhich of the follo#ing est demonstrates the full disclosure principleC
A. The multi-step income statement.
%. The auditors5 report.
C. The company5s tax return.
:. :isclosure notes to financial statements.

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7(. Four different competent accountants independently agree on the amount and method of
reporting an economic event. The concept demonstrated isA
A. *eliaility.
%. Comparaility.
C. Completeness.
:. >erifiaility.

7/. The matching principle isA
A. A valuation method.
%. An expense recognition accounting principle.
C. A cash asis reporting principle.
:. An asset classification procedure.

71. To meet the needs of full disclosure2 companies use supplemental information2 includingA
A. )arenthetical comments or modifying comments placed on the face of the financial
statements.
%. :isclosure notes conveying additional insights aout company operations2 accounting
principles2 contractual agreements2 and pending litigation.
C. Supplemental financial statements that report more detailed information than is sho#n in
the primary financial statements.
:. All of the aove are correct.

73. Ford 8otor Company purchases services from suppliers on account and sells its products
to distriutors on short-term credit. As a result2 do each of these events affect net income
faster than they affect net operating cash flo#sC

A. -ption a
%. -ption
C. -ption c
:. -ption d

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Essay Questions

Alpaca Corporation had revenues of G!002000 in its first year of operations. They have not
collected on G!02000 of their sales2 and still o#e G!/2000 on G302000 of merchandise they
purchased. The company had no inventory on hand at the end of the year. The company paid
G1/2000 in salaries. -#ners invested G!02000 in the usiness and G!02000 #as orro#ed on a
five-year note. The company paid G!2000 in interest that #as the amount o#ed for the year2
and paid G12000 for a t#o-year insurance policy on the first day of usiness. Alpaca has an
effective income tax rate of (0H.

76. Compute net income for the first year for Alpaca Corporation.

77. Compute the cash alance at the end of the first year for Alpaca Corporation.

Tri Fecta2 a partnership2 had revenues of G$102000 in its first year of operations. The
partnership has not collected on G$/2000 of its sales2 and still o#es G(02000 on G1/02000 of
merchandise they purchased. There #as no inventory on hand at the end of the year. The
partnership paid G!/2000 in salaries. The partners invested G(02000 in the usiness and
G!/2000 #as orro#ed on a five-year note. The partnership paid G$2000 in interest that #as
the amount o#ed for the year and paid G62000 for a t#o-year insurance policy on the first day
of usiness.

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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 follo#ing information ,G in millions. comes from a recent annual report of Ama&on.com2
+nc.A

10!. Compute Ama&on5s alance in cash at the eginning of the year.

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10$. Compute Ama&on5s total liailities at the end of the year.

10(. Compute cost of goods sold for the year.

10/. Compute the income efore income tax for Ama&on.

101. Compare net income ,loss. for the year to net cash flo# from operating activities. Bhy
are these amounts differentC %riefly explain.

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103. For each of the follo#ing situations2 state #hether you agree or disagree #ith the
financial reporting practice employed2 and riefly explain the reason for your ans#er.
1. Cantor Corporation5s accountant increased the oo9 value of a patent from its original cost
of G1 million to its recently appraised value of G1 million.
!. Stanton Corporation paid for the personal travel of its chief financial officer and charged
travel expense.
$. At the end of its !011 fiscal year2 :o#er2 +nc. received an order from a customer for
G102000. The merchandise #ill ship early in !01!. %ecause the sale #as made to a long-time
customer and the invoice #as paid in !0112 the controller recorded the sale in !011.
(. +n the middle of its !011 fiscal year2 Sanguinetti2 +nc. paid G1!2000 to its insurance
company for one-year comprehensive insurance coverage. Sanguinetti recorded the entire
expenditure as an expense in !011.
/. The Churchill )harmaceutical Company included a note in its financial statements that
descried a pending la#suit against the company.
1. The :aily Corporation2 a company #hose securities are pulicly traded2 prepares monthly2
"uarterly2 and annual financial statement for internal use ut disseminates to external users
only the annual financial statements.

The follo#ing ans#ers point out the 9ey phrases that should appear in students5 ans#ers.
They are not intended to e examples of complete student responses. +t might e helpful to
provide detailed instructions to students on ho# rief or in-depth you #ant their ans#ers to
e.

106. +dentify or define the follo#ing termsA a. economic entity2 . going concern.

1-!/
107. ;ist the four financial statements most fre"uently provided to external users.

110. Explain and sho# an example of ho# the FAS%5s conceptual frame#or9 is needed in
formulating standards on controversial topics.

111. Bhat is the SEC and ho# is it involved #ith accounting standard settingC

11!. Bhat is the E+TF and #hat is its purposeC

1-!1
11$. Accounting standard setting has een characteri&ed as a political process. :iscuss this
proposition giving an example.

11(. Bhat are the 9ey provisions of the )ulic Company Accounting *eform and +nvestor
)rotection ,Saranes--xley. Act of !00!C

11/. ?o# does the value of an audit affect financial statementsC

111. Bhat provisions did the )ulic Company Accounting *eform and +nvestor )rotection
,Saranes--xley. Act of !00! ma9e for performance of non-audit services y an audit firmC

1-!3
113. %riefly descrie the materiality constraint.

116. 4ive an example of a violation of the stale monetary unit assumption. ?o# #ould it
affect the "uality of financial statement informationC

117. +dentify or define the follo#ing termsA a. periodicity2 . monetary unit.

1!0. +dentify or define the follo#ing termsA a. historical cost2 . reali&ation.

1-!6
1!1. ?o# does 4AA) define fair valueC

1!!. Accounting standards have developed over time to reflect changes in the usiness #orld
as #ell as changes in our aility to account for such changes. 'sing the example of mar9ing
assets and liailities to their fair value2 explain #hy you #ould expect accounting standards to
change.

1-!7
Chapter 01 Environment and Theoretical Structure of Financial Accounting
Ans#er Eey

True / False Questions

1. The primary function of financial accounting is to provide relevant financial information to
parties external to usiness enterprises.
T!E

AACSB: Reflective thinking
Bloo!s: "no#le$ge
%e&'ning ()*ective: +,-+, .esc'i)e the function &n$ /'i&'0 focus of fin&nci&l &ccounting.
%evel of %e&'ning: E&s0

!. Accrual accounting attempts to measure revenues and expenses that occurred during
accounting periods so they e"ual net operating cash flo#.
FA"SE

Bloo!s: Co/'ehension
%e&'ning ()*ective: +,-+1 E2/l&in the $iffe'ence )et#een c&sh &n$ &cc'u&l &ccounting.

$. The FAS% is currently the pulic sector organi&ation responsile for setting accounting
standards in the '.S.
FA"SE

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%e&'ning ()*ective: +,-+3 .efine gene'&ll0 &cce/te$ &ccounting /'inci/les 34AA56 &n$ $iscuss the histo'ic&l $evelo/ent of &ccounting
st&n$&'$s.

1-$0
(. The )ulic *eform and +nvestor )rotection Act of !00! ,Saranes--xley. changed the
entity responsile for setting auditing standards in the 'nited States.
T!E

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%e&'ning ()*ective: +,-+4 E2/l&in #h0 the est&)lishent of &ccounting st&n$&'$s is ch&'&cte'i7e$ &s & /olitic&l /'ocess.

/. A rules-ased approach to standard setting stresses professional 0udgment as opposed to
follo#ing a list of rules.
FA"SE

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1. 'nder federal securities la#s2 the SEC has the authority to set accounting standards in the
'.S.
T!E

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3. The primary responsiility for properly applying 4AA) #hen communicating #ith
investors and creditors through financial statements lies #ith a firm5s auditors.
FA"SE

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%e&'ning ()*ective: +,-+6 I$entif0 the o)*ective of fin&nci&l 'e/o'ting8 the 9u&lit&tive ch&'&cte'istics of fin&nci&l 'e/o'ting info'&tion8 &n$
the eleents of fin&nci&l st&teents.

1-$1
6. Auditors play an important role in the resource allocation process y adding crediility to
financial statements.
T!E


7. 8ateriality can e affected y the dollar amount of an item2 the nature of the item2 or oth.
T!E

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10. Conservatism is a desired "ualitative characteristic of accounting information.
FA"SE

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11. E"uity is a residual amount representing the o#ner5s interest in the assets of the usiness.
T!E

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1-$!
1!. *evenues are inflo#s or other enhancements of assets or settlements of liailities from
activities that constitute the entity5s ongoing operations.
T!E

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1$. 4ains or losses result2 respectively2 from the disposition of usiness assets for greater
than2 or less than2 their oo9 values.
T!E

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1(. Comprehensive income is another term for net income.
FA"SE

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1/. :etermining fair value y calculating the present value of future cash flo#s is a level 1
type of input.
FA"SE

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%e&'ning ()*ective: +,-+: .esc'i)e the fou' )'o&$ &ccounting /'inci/les th&t gui$e &ccounting /'&ctice.

1-$$
11. The FAS%5s frame#or9 for measuring fair value doesn5t change the situations in #hich
fair value is used under current 4AA).
T!E

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Matching Questions

1. )redictive value +nformation is useful in pro0ecting cash flo#s. 1
!. *elevance )ertinent to the decision at hand. #
$. :istriution to o#ners +nformation is availale prior to the decision. $
(. Confirmatory value :ecrease in e"uity due to transfers to o#ners. %
/. Timeliness +nformation confirms expectations. &


1. 4ain
Along #ith relevance2 a fundamental decision-
specific "uality. $
!. 8ateriality *esults if an asset is sold for more than oo9 value. 1
$. Completeness
+nformation contains all information necessary for
faithful representation. %
(. Comprehensive
income The change in e"uity from nono#ner transactions. &
/. Faithful
representation
Concerns the decision-ma9ing impact of oth the
amount and nature of an item. #


1-$(
of the terms. 8atch each phrase #ith the correct term #ith their phrases y placing the letter
designating the est term in the space provided y the phrase.
1. =eutrality +mportant in analysis et#een firms. #
!. Comparaility Accounting information should e uniased. 1
$. Consistency The process of including data in financial statements. $
(. Cost
effectiveness Applying the same accounting practices over time. %
/. *ecognition
Considers the value of using information relative to
cost of providing it. &


!0. ;isted elo# are ten terms are follo#ed y a list of phrases that descrie or characteri&e
five of the terms. 8atch each phrase #ith the correct term y placing the letter designating the
est term in the space provided y the phrase.
1. 8onetary unit
assumption +mplies consensus among different oservers. #
!. >erifiaility
Assumes all transactions can e identified #ith a
particular entity. %
$. Economic entity
assumption
Assumes an entity #ill continue to operate
indefinitely. &
(. 4oing concern
assumption
*e"uires reporting the financial life of an entity in
discrete time frames. $
/. )eriodicity assumption +gnores the possiility of inflation. 1


1-$/
!1. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. ?istorical cost
principle %asis of measurement for fixed assets. 1
!. 8ateriality
*ecognition of revenue only after certain criteria
are satisfied. $
$. 8atching principle 4uide to expense recognition. %
(. Full-disclosure
principle
*eporting of all information that could affect
decisions. &
/. *eali&ation principle
Application of 4AA) sometimes avoided under
this constraint. #


!!. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. Financial Accounting
Standards %oard
+t is a practical 0ustification for choosing
among alternative accounting methods. %
!. Accounting )rinciples
%oard +t estalished 4AA) efore the FAS%. #
$. Conservatism
+ts EITF Issues are 4AA) #hen entered in the
Accounting Standards Codification. 1
(. A+C)A
+t has the authority to set '.S. accounting
standards. $
/. Securities and Exchange
Commission
+t is the national organi&ation for C)As in the
'.S. &


1-$1
!$. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. Expenses =et assets. #
!. E"uity -utflo#s of resources to generate revenues. 1
$. :istriutions to
o#ners Cash dividends. %
(. +nvestments y
o#ners Claims of creditors against the assets of a usiness. $
/. ;iailities
Transfers of resources in exchange for common and
preferred stoc9. &

Bloo!s: "no#le$ge

!(. ;isted elo# are ten terms follo#ed y a list of phrases that descrie or characteri&e five
1. ;osses =et outflo#s from peripheral transactions. 1
!. Assets
+ncreases in e"uity from the sale of goods and@or
services. %
$. *evenues
value. $
(. Comprehensive
income All changes in e"uity except o#ner transactions. &
/. 4ains
)roale future economic enefits controlled y
an entity. #

Bloo!s: "no#le$ge

1-$3
!/. ;isted elo# are ten organi&ations follo#ed y a list of phrases that descrie or
characteri&e the organi&ations. 8atch each phrase #ith the correct organi&ation y placing the
letter designating the est term in the space provided y the phrase.
1. SEC
Estalishes auditing standards in the '.S for pulic
companies. '
!. FAS%
)rimary national organi&ation of accountants #or9ing in
industry. (
$. +AS% Sets accounting standards in the '.S. #
(. A+C)A )rovides timely responses to financial reporting issues. $
/. E+TF The FAS%5s parent organi&ation. 10
1. )CA-% )arent organi&ation of the +AS%. )
3. +8A FAS%5s predecessor. *
6. +ASC *egulates the financial reporting for pulic companies. 1
7. A)% =ational organi&ation of certified pulic accountants. &
10. FAF Sets gloal accounting standards. %

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Multiple Choice Questions

!1. External decision ma9ers #ould not loo9 primarily to financial accounting information to
assist them in ma9ing decisions onA
A. 4ranting credit.
+, Capital udgeting.
C. Selecting stoc9s.
:. 8ergers and ac"uisitions.


1-$6
!3. Corporations issue their shares to the investing pulic in theA

A. -ption A
%. -ption %
C, -ption C
:. -ption :

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!6. The primary focus for financial accounting information is to provide information useful
forA

A, -ption A
%. -ption %
C. -ption C
:. -ption :

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1-$7
!7. Bhich of the follo#ing is not true aout net operating cash flo#C
A. +t is the difference et#een cash receipts and cash disursements 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 flo#s.
C. -ver short periods of time2 it may not e indicative of long-run cash-generating aility.
:. +t is easy to understand and all information re"uired to measure it is factual.

Bloo!s: "no#le$ge
%evel of %e&'ning: ;e$iu

$0. Bhich of the follo#ing groups is not among financial intermediariesC
A. 8utual fund managers
%. Financial analysts
C, C)As
:. Credit rating organi&ations

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$1. Bhich of the follo#ing #as 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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1-(0
$!. Bhich of the follo#ing does not apply to secondary mar9etsC
A. Transactions are important to the efficient allocation of resources in our economy.
+, =e# resources are provided #hen shares of stoc9 are sold y the corporation to the initial
o#ners.
C. Transactions help to estalish mar9et prices for additional shares that may e issued in the
future.
:. 8any investors might e un#illing to provide resources to corporations if there is no
availale mechanism for the future sale of their stoc9s and onds to others.

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$$. A cause-and-effect relationship is implicit in theA
A. *eali&ation principle.
%. ?istorical cost principle.
C, 8atching principle.
:. 4oing concern assumption.

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$(. The full disclosure principle re"uires a alance et#eenA
A. Comparaility and consistency.
+, *elevance and cost effectiveness.
C. *eliaility and neutrality.
:. Timeliness and predictive value.


1-(1
$/. Bhich of the follo#ing groups is not among the external users for #hom financial
statements are preparedC
A. Customers
%. Suppliers
C. Employees
-, All of the aove are external users of financial statements.

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$1. +n a recent annual report2 Apple Computer reported the follo#ing in one of its disclosure
notesA DBarranty ExpenseA The Company provides currently for the estimated cost for product
#arranties at the time the related revenue is recogni&ed.D This note exemplifies Apple5s use
ofA
A. Conservatism
+, The matching principle
C. *eali&ation principle
:. Economic entity

Bloo!s: S0nthesis

$3. 4AA) is an areviation forA
A. 4enerally authori&ed accounting procedures.
%. 4enerally applied accounting procedures.
C. 4enerally accepted auditing practices.
-, 4enerally accepted accounting principles.

Bloo!s: "no#le$ge
st&n$&'$s.

1-(!
$6. The SEC issues accounting standards in the form ofA
A. Accounting *esearch %ulletins.
+, Financial *eporting *eleases.
C. Financial Accounting Standards.
:. Financial Technical %ulletins.

Bloo!s: "no#le$ge
st&n$&'$s.

$7. )ronouncements issued y the Committee on Accounting )roceduresA
A, :ealt #ith specific accounting and reporting prolems.
%. Bere ased on exposure drafts and pulic comment letters.
C. -riginated from congressional studies and SEC directives.
:. Bere the outcome of research studies and a theoretical frame#or9.

Bloo!s: "no#le$ge
st&n$&'$s.

(0. The FAS%5s standard-setting process includes2 in the correct orderA
A. Exposure draft2 research2 discussion paper2 Accounting Standards 'pdate.
%. *esearch2 exposure draft2 discussion paper2 Accounting Standards 'pdate.
C, *esearch2 discussion paper2 exposure draft2 Accounting Standards 'pdate.
:. :iscussion paper2 research2 exposure draft2 Accounting Standards 'pdate.

Bloo!s: "no#le$ge
st&n$&'$s.

1-($
+nvestor )rotection Act of !00! ,Saranes--xley.C The ActA
A. Changed the entity responsile for setting auditing standards.
%. +ncreased corporate executive responsiility for financial statements.
C. ;imited nonaudit services that can e performed y auditors for audit clients.
-, Changed the entity responsile for setting accounting standards.

Bloo!s: "no#le$ge
st&n$&'$s.

(!. C)As are licensed yA
A. The A+C)A.
%. The SEC.
C. The federal government.
-, State governments.

Bloo!s: "no#le$ge
st&n$&'$s.

($. A firm5s comprehensive income al#aysA
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.


1-((
((. Bhich of the follo#ing has the authority to set accounting standards in the 'nited StatesC
A. FAS%
%. +*S
C, SEC
:. A+C)A

Bloo!s: "no#le$ge
st&n$&'$s.

(/. The most li9ely important fla# leading to the demise of the A)% #as the perceived lac9
ofA
A. Confidence.
%. Competence.
C, +ndependence.
:. +mportance.

Bloo!s: "no#le$ge
st&n$&'$s.

(1. Accounting standard setting has een characteri&ed asA
A, A political process.
%. 'sing the scientific method.
C. )ure deductive reasoning.
:. )ure inductive reasoning.

Bloo!s: "no#le$ge

1-(/
(3. The +nternational Accounting Standards %oardA
A. Bas the predecessor to the +ASC.
%. Can overrule the FAS% #hen their policies disagree.
C, )romotes the use of high-"uality2 understandale gloal accounting standards.
:. ?as its head"uarters in 4eneva.

Bloo!s: "no#le$ge

(6. The most political issue in the FAS%5s most recent delierations and amendments to
4AA) on usiness cominations #asA
A, The negative effects on suse"uent earnings of amorti&ing good#ill if firms #ere re"uired
to use the purchase method of accounting for the comination.
%. The negative effects on suse"uent earnings of amorti&ing good#ill if firms #ere re"uired
to use the pooling method of accounting for the comination.
C. The unrealistic alance sheet assets that #ould e created if firms #ere re"uired to use the
purchase method of accounting for the comination.
:. The unrealistic alance sheet assets that #ould e created if firms #ere re"uired to use the
pooling method of accounting for the comination.


+nvestor )rotection Act of !00!C
A. Corporate executive accountaility.
%. Auditor rotation.
C. *etention of #or9papers.
-, All of the aove are provisions of the Act.

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1-(1
/0. Bhen a registrant company sumits its annual filing to the SEC2 it usesA
A. Form 10-A.
+, Form 10-E.
C. Form 10-F.
:. Form S-1.

Bloo!s: "no#le$ge
st&n$&'$s.

/1. The primary professional organi&ation for those accountants #or9ing in industry is theA
A. AAA
%. A+C)A
C. ++A
-, +8A

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/!. The primary historical reason for the FAS% reversing its positions #hen political
pressures occur isA
A. The cost of gathering data #as prohiitive.
%. The difficulties in measurement #ere too great.
C. They have no authority in such situations.
-, The SEC did not support the FAS% position.

Bloo!s: "no#le$ge

1-(3
/$. The most recent example of the political process at #or9 in standard setting is the heated
deate that occurred on the issue ofA
A. )ension plan accounting.
%. Accounting for posteretirement enefits other than pensions.
C, Accounting for usiness cominations.
:. Accounting for stoc9-ased compensation.


/(. The recognition of #hich of the follo#ing expenses exemplifies the application of the
matching principleC
A. )resident5s salary.
%. *esearch and development.
C, Cost of goods sold.
:. Advertising.


//. The FAS%5s conceptual frame#or95s "ualitative characteristics of accounting information
includeA
A. ?istorical cost.
%. *eali&ation.
C, Faithful representation.
:. Full disclosure.

Bloo!s: "no#le$ge
%e&'ning ()*ective: +,-+5 E2/l&in the /u'/ose of the FASB!s conce/tu&l f'&e#o'k.

1-(6
/1. The FAS%5s conceptual frame#or95s "ualitative characteristics of accounting information
includeA
A. Full disclosure.
+, *elevance.
C. 4oing concern.
:. ?istorical cost.

Bloo!s: "no#le$ge

/3. The conceptual frame#or95s "ualitative characteristic of relevance includesA
A, )redictive value.
%. >erifiaility.
C. Completeness.
:. =eutrality.

Bloo!s: "no#le$ge

/6. The conceptual frame#or95s "ualitative characteristic of faithful representation includesA
+, =eutrality.
C. Confirmatory value.
:. Timeliness.

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1-(7
/7. The conceptual frame#or95s recognition and measurement concepts recogni&e #hich of
the follo#ing as an assumption2 rather than a principleC
A, 4oing concern.
%. ?istorical cost.
C. Full disclosure.
:. *eali&ation.

Bloo!s: "no#le$ge
%e&'ning ()*ective: +,-+< .esc'i)e the fou' )&sic &ssu/tions un$e'l0ing 4AA5.

10. The conceptual frame#or95s recognition and measurement concepts recogni&e #hich of
the follo#ing as a principle2 rather than an assumptionC
A. )eriodicity.
%. 8onetary unit.
C. Conservatism.
-, Full disclosure.

Bloo!s: "no#le$ge

11. )hase A of the ne# conceptual frame#or9 focuses onA
A, -0ective and "ualitative characteristics.
%. )resentation and disclosure.
C. *ecognition and measurement.

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1-/0
1!. The primary o0ective of financial accounting information is to provide useful information
toA
A. 8anagement.
%. Capital providers.
C. *egulators.
-, =one of the aove.


1$. SFAC No.5 focuses onA
A. -0ectives of financial reporting.
%. Fualitative characteristics of accounting information.
C, *ecognition and measurement concepts in accounting.

Bloo!s: "no#le$ge

1(. The main issue in the deate over accounting for employee stoc9 options #asA
A. Bhich employees should receive options.
+, The amount of compensation expense that a company should recogni&e.
C. ?o# many options should e granted to 9ey executives.
:. The tax conse"uences of employee stoc9 options.


1-/1
1/. =et income e"ualsA
A. Assets minus liailities.
%. *evenues minus cost of goods sold.
C, *evenues minus expenses.
:. Cash receipts minus cash payments.

Bloo!s: "no#le$ge

11. Enhancing "ualitative characteristics of accounting information include each of the
follo#ing exceptA
A. Timeliness.
+, 8ateriality.
C. Comparaility.
:. >erifiaility.

Bloo!s: "no#le$ge

13. The enhancing "ualitative characteristic of understandaility means that information
should e understood yA
A. Those #ho are experts in the interpretation of financial information.
+, Those #ho have a reasonale understanding of usiness and economic activities.
C. Financial analysts.
:. C)As.

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1-/!
16. Fundamental "ualitative characteristics of accounting information areA
%. Comparaility and consistency.
C, Faithful representation and relevance.

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17. Enhancing "ualitative characteristics of accounting information includeA
+, Comparaility and timeliness.
C. 'nderstandaility and relevance.

Bloo!s: "no#le$ge

30. 4ains areA
A. +nflo#s from selling a product or service to a customer.
%. +ncreases in e"uity resulting from transfers of assets to the company from o#ners.
C, +ncreases in e"uity from peripheral transactions of an entity.

Bloo!s: "no#le$ge

1-/$
31. Bhen there is agreement et#een a measure or description and the phenomenon it
purports to represent2 information possesses #hich characteristicC
A. >erifiaility.
%. )redictive value.
C, Faithful representation.
:. Timeliness.

Bloo!s: S0nthesis

3!. Surefeet Corporation changed its inventory valuation method. Bhich characteristic is
0eopardi&ed y this changeC
A. Comparaility.
%. *epresentational faithfulness.
C, Consistency.
:. Feedac9 value.

Bloo!s: S0nthesis

3$. -f the follo#ing2 the most important o0ective for financial reporting is to provide
information useful forA
A, 8a9ing decisions.
%. :etermining taxale income.
C. )roviding accountaility.
:. +ncreasing future profits.

Bloo!s: "no#le$ge

1-/(
3(. +ndependent auditors express an opinion on theA
A, Fairness of financial statements.
%. Accuracy of financial statements.
C. Soundness of a company5s future.
:. Fuality of a company5s management.

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3/. Constraints on "ualitative characteristics of accounting information includeA
A. Timeliness.
%. 4oing concern.
C. =eutrality.
-, 8ateriality.

Bloo!s: "no#le$ge

31. Elements of financial statements do not includeA
A, 8onetary unit.
%. +nvestments y o#ners.
C. Comprehensive income.
:. ;osses.

Bloo!s: "no#le$ge

1-//
33. According to the conceptual frame#or92 verifiaility impliesA
A. ;egal evidence.
%. ;ogic.
C, Consensus.
:. ;egal verdict.

Bloo!s: S0nthesis

36. ;and #as ac"uired in !011 for a future uilding site at a cost of G(02000. The assessed
valuation for tax purposes is G!320002 a "ualified appraiser placed its value at G(620002 and a
recent firm offer for the land #as for a cash payment of G(12000. The land should e reported
in the financial statements atA
A, G(02000.
%. G!32000.
C. G(12000.
:. G(62000.

AACSB: An&l0tic
Bloo!s: A//lic&tion

37. 8altec Corporation has started placing its "uarterly financial statements on its #e page2
therey reducing y ten days the time to get information to investors and creditors. The
"ualitative concept improved isA
A. Comparaility.
%. Consistency.
C, Timeliness.
:. Faithful representation.

Bloo!s: S0nthesis

1-/1
60. *ecogni&ing expected losses immediately2 ut deferring expected gains2 is an example ofA
A. 8ateriality.
+, Conservatism.
:. Timeliness.

Bloo!s: "no#le$ge

61. Change in e"uity from nono#ner sources isA
A, Comprehensive income.
%. *evenues.
C. Expenses.
:. 4ains and losses.

Bloo!s: "no#le$ge

6!. The assumption that in the asence of contrary information a usiness entity #ill continue
indefinitely is theA
A. )eriodicity assumption.
%. Entity assumption.
C, 4oing concern assumption.
:. ?istorical cost assumption.

Bloo!s: "no#le$ge

1-/3
6$. Bhich of the follo#ing Statements of Financial Accounting Concepts defines the 10
elements of financial statementsC
A. SFAC 4
%. SFAC 3
C. SFAC 5
-, SFAC 6

Bloo!s: "no#le$ge

6(. The possiility that the capital mar9ets5 focus on periodic profits may tempt a company5s
management to end or even rea9 accounting rules to inflate reported net income is an
example ofA
A, An ethical dilemma.
%. An accounting theory issue.
C. A technical accounting issue.
:. =one of the aove is correct.

Bloo!s: S0nthesis

6/. -ne of the elements that many elieve distinguishes a profession from other occupations
is the acceptance y its memers of a responsiility for the interests of those it serves2 often
articulated inA
A. +ts conceptual frame#or9.
+, +ts code of ethics.
C. Federal la#s.
:. State la#s.

Bloo!s: "no#le$ge

1-/6
61. )rimecoat Corporation could disseminate its annual financial statements t#o days earlier
if it shifted sustantial human resources from other operations to the annual report pro0ect.
8anagement decided the value of the earlier report #as not #orth the added commitment of
resources. The concept demonstrated isA
A. Timeliness.
%. 8ateriality.
C. *elevance.
-, Cost effectiveness.

Bloo!s: A//lic&tion

63. 8ega ;oan Company has very stringent credit re"uirements and2 accordingly2 has
negligile losses from uncollectile accounts. The company5s independent accountants did not
protest #hen2 contrary to 4AA)2 the company recorded ad det expense only #hen specific
accounts #ere determined to e uncollectile2 rather than use an allo#ance for uncollectile
accounts. The concept demonstrated isA
A. Comparaility.
%. Faithful representation.
-, 8ateriality.

Bloo!s: A//lic&tion

66. An important argument in support of historical cost information isA
A. *elevance.
%. )redictive "uality for future cash flo#s.
C. 8ateriality.
-, >erifiaility.


1-/7
67. +f a company has gone an9rupt2 its financial statements li9ely violateA
A. The matching principle.
%. The reali&ation principle.
C. The stale monetary unit assumption.
-, The going concern assumption.

Bloo!s: S0nthesis

70. *evenue should not e recogni&ed untilA
A, The earnings process is complete and collection is reasonaly assured.
%. Contracts have een signed and payment has een received.
C. Bor9 has een performed and customer has een illed.
:. Collection has een made and #arrantees have expired.

Bloo!s: "no#le$ge

71. Bhich of the follo#ing is not an identified valuation techni"ue in 4AA) regarding fair
value measurementC
A. Cost approach.
%. 8ar9et approach.
C, Cost-enefit approach.
:. +ncome approach.

Bloo!s: "no#le$ge

1-10
7!. :isclosure notes to a company5s financial statementsA
A. Are relatively unimportant facts that don5t elong in the asic financial statements.
%. :ocument the source of financial statement facts2 li9e literary footnotes.
C, Are an integral part of a company5s financial statements.
:. Are irrelevant facts that are immaterial in amount.

Bloo!s: "no#le$ge

7$. Bhich of the follo#ing est demonstrates the full disclosure principleC
A. The multi-step income statement.
%. The auditors5 report.
C. The company5s tax return.
-, :isclosure notes to financial statements.

Bloo!s: S0nthesis

7(. Four different competent accountants independently agree on the amount and method of
reporting an economic event. The concept demonstrated isA
A. *eliaility.
%. Comparaility.
C. Completeness.
-, >erifiaility.


1-11
7/. The matching principle isA
A. A valuation method.
+, An expense recognition accounting principle.
C. A cash asis reporting principle.
:. An asset classification procedure.

Bloo!s: "no#le$ge

71. To meet the needs of full disclosure2 companies use supplemental information2 includingA
A. )arenthetical comments or modifying comments placed on the face of the financial
statements.
%. :isclosure notes conveying additional insights aout company operations2 accounting
principles2 contractual agreements2 and pending litigation.
C. Supplemental financial statements that report more detailed information than is sho#n in
the primary financial statements.
-, All of the aove are correct.

Bloo!s: "no#le$ge

1-1!
73. Ford 8otor Company purchases services from suppliers on account and sells its products
to distriutors on short-term credit. As a result2 do each of these events affect net income
faster than they affect net operating cash flo#sC

A, -ption a
%. -ption
C. -ption c
:. -ption d

AACSB: An&l0tic
Bloo!s: An&l0sis
%evel of %e&'ning: =&'$

Essay Questions

Alpaca Corporation had revenues of G!002000 in its first year of operations. They have not
collected on G!02000 of their sales2 and still o#e G!/2000 on G302000 of merchandise they
purchased. The company had no inventory on hand at the end of the year. The company paid
G1/2000 in salaries. -#ners invested G!02000 in the usiness and G!02000 #as orro#ed on a
five-year note. The company paid G!2000 in interest that #as the amount o#ed for the year2
and paid G12000 for a t#o-year insurance policy on the first day of usiness. Alpaca has an
effective income tax rate of (0H.

1-1$
76. Compute net income for the first year for Alpaca Corporation.

AACSB: An&l0tic
Bloo!s: A//lic&tion

77. Compute the cash alance at the end of the first year for Alpaca Corporation.

AACSB: An&l0tic
Bloo!s: A//lic&tion

1-1(
Tri Fecta2 a partnership2 had revenues of G$102000 in its first year of operations. The
partnership has not collected on G$/2000 of its sales2 and still o#es G(02000 on G1/02000 of
merchandise they purchased. There #as no inventory on hand at the end of the year. The
partnership paid G!/2000 in salaries. The partners invested G(02000 in the usiness and
G!/2000 #as orro#ed on a five-year note. The partnership paid G$2000 in interest that #as
the amount o#ed for the year and paid G62000 for a t#o-year insurance policy on the first day
of usiness.

100. Compute net income for the first year for Tri Fecta.

AACSB: An&l0tic
Bloo!s: A//lic&tion

1-1/
101. Compute the cash alance at the end of the first year for Tri Fecta.

AACSB: An&l0tic
Bloo!s: A//lic&tion

The follo#ing information ,G in millions. comes from a recent annual report of Ama&on.com2
+nc.A

1-11
10!. Compute Ama&on5s alance in cash at the eginning of the year.
%eginning alance in Cash I =et increase in Cash J Ending alance in Cash
Therefore2 eginning alance in Cash J Ending alance in Cash - =et increase in Cash
J G120!! - 7 J G1201$

AACSB: An&l0tic
Bloo!s: A//lic&tion

10$. Compute Ama&on5s total liailities at the end of the year.
Total assets J Total liailities I Total Stoc9holders5 e"uity
Therefore2 Total liailities J Total assets - Total Stoc9holders5 e"uity J
G(2$1$ - ($1 J G$27$!

AACSB: An&l0tic
Bloo!s: A//lic&tion

10(. Compute cost of goods sold for the year.
4ross profit J =et sales - Cost of goods sold
Therefore2 Cost of goods sold J =et sales - 4ross profit
J G102311 - !2(/1 J G62!//

AACSB: An&l0tic
Bloo!s: A//lic&tion

1-13
10/. Compute the income efore income tax for Ama&on.
=et income J 4ross profit - -perating expenses I -ther income ,expense.2 net
J G!2(/1 - !2013 I ,1!. J G$33

AACSB: An&l0tic
Bloo!s: A//lic&tion

101. Compare net income ,loss. for the year to net cash flo# from operating activities. Bhy
are these amounts differentC %riefly explain.
These amounts are different ecause of the differences et#een cash and accrual accounting.
As opposed to cash flo#s from operations2 net income includes oth revenues and expenses
the timing of #hich differs from the timing of certain cash receipts and payments. Examples
#ould e credit sales in #hich the revenues are recorded efore the collection of cash and cost
of goods sold in #hich the expense often is recorded later than the cash payment to the
supplier for the merchandise.

AACSB: An&l0tic> Counic&tions

1-16
103. For each of the follo#ing situations2 state #hether you agree or disagree #ith the
financial reporting practice employed2 and riefly explain the reason for your ans#er.
1. Cantor Corporation5s accountant increased the oo9 value of a patent from its original cost
of G1 million to its recently appraised value of G1 million.
!. Stanton Corporation paid for the personal travel of its chief financial officer and charged
travel expense.
$. At the end of its !011 fiscal year2 :o#er2 +nc. received an order from a customer for
G102000. The merchandise #ill ship early in !01!. %ecause the sale #as made to a long-time
customer and the invoice #as paid in !0112 the controller recorded the sale in !011.
(. +n the middle of its !011 fiscal year2 Sanguinetti2 +nc. paid G1!2000 to its insurance
company for one-year comprehensive insurance coverage. Sanguinetti recorded the entire
expenditure as an expense in !011.
/. The Churchill )harmaceutical Company included a note in its financial statements that
descried a pending la#suit against the company.
1. The :aily Corporation2 a company #hose securities are pulicly traded2 prepares monthly2
"uarterly2 and annual financial statement for internal use ut disseminates to external users
only the annual financial statements.
1. :isagree K This is a violation of the historical cost ,original transaction value. principle.
!. :isagree K This is a violation of the economic entity assumption.
$. :isagree K This is a violation of the reali&ation ,revenue recognition. principle.
(. :isagree K This is a violation of the matching principle.
/. Agree K The company is conforming to the full disclosure principle.
1. :isagree K This is a violation of the periodicity assumption.

AACSB: An&l0tic
Bloo!s: A//lic&tion

The follo#ing ans#ers point out the 9ey phrases that should appear in students5 ans#ers.
They are not intended to e examples of complete student responses. +t might e helpful to
provide detailed instructions to students on ho# rief or in-depth you #ant their ans#ers to
e.

1-17
106. +dentify or define the follo#ing termsA a. economic entity2 . going concern.
Economic entity - All economic events can e identified #ith a particular economic entity.
4oing concern- +n the asence of information to the contrary2 it is anticipated that a usiness
entity #ill continue to operate indefinitely.

Bloo!s: "no#le$ge

107. ;ist the four financial statements most fre"uently provided to external users.
%alance sheet2 +ncome statement2 Statement of cash flo#s2 Statement of shareholders5 e"uity.

Bloo!s: "no#le$ge

110. Explain and sho# an example of ho# the FAS%5s conceptual frame#or9 is needed in
formulating standards on controversial topics.
There are many possile examples here. For example2 in deating accounting for stoc9-ased
compensation2 the FAS%5s conceptual frame#or9 explains the rationale for treating stoc9
options as an expense. %y relating the accounting for such compensation to the purpose of
financial statements and their "ualitative characteristics2 the FAS% can defend its positions
#ithout the ias inherent in such controversial issues.

st&n$&'$s.

1-30
111. Bhat is the SEC and ho# is it involved #ith accounting standard settingC
The Securities and Exchange Commission is a federal agency that has the authority to set
accounting standards. ?o#ever2 the SEC has al#ays delegated the tas9 to a private sector
ody2 such as the current FAS%.

Bloo!s: "no#le$ge

11!. Bhat is the E+TF and #hat is its purposeC
The Emerging +ssues Tas9 Force ,E+TF. acts as a filter for the FAS%. +t includes 1/
individuals from pulic accounting and private industry along #ith a representative from the
FAS% and an SEC oserver. The tas9 force focuses on emerging issues and attempts to reach
a consensus2 speeding up the standard-setting process.

Bloo!s: "no#le$ge

11$. Accounting standard setting has een characteri&ed as a political process. :iscuss this
proposition giving an example.
Changes in 4AA) can have significant differential effects on companies2 investors2 creditors2
and other interest groups. The FAS% must gauge the economic conse"uences of a change in
accounting standards. The process y #hich financial accounting standards are created
includes pulic comment and sometimes hearings. 'ltimately2 a vote must e ta9en to pass a
proposed change in 4AA). Accounting for stoc9-ased compensations ,options. and post-
retirement health care enefits are examples #here accounting practices have een affected y
political influences on 4AA).

Bloo!s: S0nthesis

1-31
11(. Bhat are the 9ey provisions of the )ulic Company Accounting *eform and +nvestor
)rotection ,Saranes--xley. Act of !00!C
The act provides for the regulation of auditors and the types of services they furnish to clients2
increases accountaility of corporate executives2 addresses conflicts of interest for auditors
and securities analysts2 and re"uires that companies document and assess their internal
controls2 that auditors express an opinion on management5s assessment of internal controls2
and re"uires auditors to express their o#n opinion on company internal controls.

Bloo!s: "no#le$ge

11/. ?o# does the value of an audit affect financial statementsC
-utside auditors add crediility to financial statements2 increasing the confidence of capital
mar9et participants #ho rely on financial statements in ma9ing investment and credit
decisions and recommendations.


111. Bhat provisions did the )ulic Company Accounting *eform and +nvestor )rotection
,Saranes--xley. Act of !00! ma9e for performance of non-audit services y an audit firmC
The la# ma9es it unla#ful for the auditors of pulic companies to perform a variety of non-
audit services for audit clients. )rohiited services include oo99eeping2 internal audit
outsourcing2 appraisal or valuation services2 and various other consulting services. -ther non-
audit services2 including tax services2 re"uire pre-approval y the audit committee of the
company eing audited.

Bloo!s: "no#le$ge

1-3!
113. %riefly descrie the materiality constraint.
8ateriality - +nformation is material if it can have an effect on a decision made y a user. +f an
item is not material2 4AA) need not e follo#ed. For example2 if a large corporation
purchased a #ater cooler for one of its common areas for G1!02 the amount could e expensed
rather than recorded as an asset even though the cooler #ill e useful for several years.
8ateriality is a 0udgment call. 8ateriality is concerned #ith oth the dollar amount of an item
and@or the nature of an item. +t #ould proaly e material if 8icrosoft received G120002000
in ries from the Chinese for its technology. A G120002000 #rite-off of old e"uipment #ould
proaly e immaterial for 8icrosoft.


116. 4ive an example of a violation of the stale monetary unit assumption. ?o# #ould it
affect the "uality of financial statement informationC
+n a place or time in #hich a country experiences severe inflation2 this #ould violate the
assumption that dollar amounts are constantly valued. This #ould limit the usefulness of
adding numers in financial statements2 ecause ,for instance. costs at different times are not
comparale #ithout ad0usting for changes in purchasing po#er.


117. +dentify or define the follo#ing termsA a. periodicity2 . monetary unit.
)eriodicity - The life of a company can e divided into artificial time periods to provide
timely information to external users.
8onetary unit- +n the '.S.2 financial statement elements should e measured in terms of the
'.S. dollar. +t assumes that the value of a dollar is stale over time.

Bloo!s: "no#le$ge

1-3$
1!0. +dentify or define the follo#ing termsA a. historical cost2 . reali&ation.
?istorical cost - Asset and liaility measurements should e ased on the amount given or
received in an exchange transaction.
*eali&ation - *evenue should e recogni&ed only after the earnings process is virtually
complete and there is reasonale certainty of collecting the asset to e received from the
customer.

Bloo!s: "no#le$ge

1!1. ?o# does 4AA) define fair valueC
Fair value is defined as the price that #ould e received to sell assets or paid to transfer a
liaility in an orderly transaction et#een mar9et participants at the measurement date.

Bloo!s: "no#le$ge

1!!. Accounting standards have developed over time to reflect changes in the usiness #orld
as #ell as changes in our aility to account for such changes. 'sing the example of mar9ing
assets and liailities to their fair value2 explain #hy you #ould expect accounting standards to
change.
?istorically2 financial accounting relied on transaction amounts ,historical cost. as the
fundamental measurement approach for reporting assets and liailities. As mar9ets have
matured2 it is more relevant and feasile to report some assets and liailities at their fair
values2 particularly if such items have a ready mar9et that is active.

Bloo!s: S0nthesis

1-3(

Chap 00127

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Chapter 01 - Environment and Theoretical Structure of Financial Accounting

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