01 Accounting concepts Flashcards
(37 cards)
If a fraudster wanted to conceal the removal of a liability from the books, which of the following actions would NOT balance the accounting equation?
A. Increasing a different liability
B. Increasing owner’s equity
C. Increasing revenue
D. Increasing an asset
D. Increasing an asset
The accounting equation, Assets = Liabilities + Owners’ Equity, is the basis for all double-entry accounting. Suppose that in order to make an organization appear that it has less debt, an accountant fraudulently removes a liability. This would leave the accounting equation unbalanced since the assets side would be greater than liabilities plus owners’ equity. In this particular case, the equation can be balanced by decreasing an asset, increasing a different liability, increasing an owners’ equity account, increasing revenues (and thus retained earnings), or reducing an expense (and thus increasing retained earnings). Increasing an asset would only make the equation further out of balance.
The statement of changes in owners’ equity acts as the connecting link between which two financial statements?
A. Balance sheet and statement of retained earnings
B. Income statement and balance sheet
C. Statement of cash flows and balance sheet
D. Income statement and statement of cash flows
B. Income statement and balance sheet
The statement of changes in owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet. Because it shows how the amounts on the income statement flow through to the balance sheet, it acts as the connecting link between the two statements. The balance of the owners’ equity at the beginning of the year is the starting point for the statement. The transactions that affect owner’s’ equity are listed next and are added together. The result is added to (or subtracted from, if negative) the beginning-of-the-year balance, which provides the end-of-the-year balance for total owners’ equity.
Which accounting principle requires corresponding expenses and revenue to be recorded in the same accounting period?
A. Going concern
B. Matching
C. Faithful representation
D. Comparability
B. Matching
Expenses are recognized in the income statement on the basis of a direct association between the costs incurred and the earning of specific items of income. This process, commonly referred to as the matching principle, involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events; for example, the various components of expense making up the cost of goods sold are recognized at the same time as the income derived from the sale of the goods.
Which of the following statements is NOT true regarding the statement of cash flows?
A. There are three types of cash flows: cash flows from operating activities, from investing activities, and from financing activities.
B. The statement of cash flows reports a company’s sources and uses of cash during the accounting period.
C. The statement of cash flows is often used in tandem with the income statement to determine a company’s true financial performance.
D. The statement of cash flows shows a company’s financial position at a specific point in
time.
D. The statement of cash flows shows a company’s financial position at a specific point in
time.
The statement of cash flows reports a company’s sources and uses of cash during the accounting period. This statement is often used by potential investors and other interested parties in tandem with the income statement to determine a company’s true financial performance during the period being reported. The statement of cash flows is broken down into three sections: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities.
The balance sheet shows a company’s financial position at a specific point in time.
Which of the following statements is TRUE with regard to gross margin?
A. Gross margin is equal to revenues less operating expenses.
B. Gross margin is the top line of the income statement.
C. Gross margin is another term for net income.
D. Gross margin is equal to net sales less cost of goods sold.
D. Gross margin is equal to net sales less cost of goods sold.
Two basic types of accounts are reported on the income statement—revenues and expenses. Revenues represent amounts received from the sale of goods or services during the accounting period. Most companies present net sales as the first line item on the income statement. The term net means that the amount shown is the company’s total sales minus any sales refunds, returns, discounts, or allowances.
From net sales, an expense titled cost of goods sold or cost of sales is deducted. Regardless of the industry, this expense denotes the amount a company spent (in past, present, and/or future accounting periods) to produce the goods or services that were sold during the current period. The difference between net sales and cost of goods sold is called gross margin, or gross profit, which represents the amount left over from sales to pay the company’s operating expenses.
Revenue should not be recognized for work that is to be performed in subsequent accounting periods, even though the work might currently be under contract.
A. True
B. False
A. True
In general, revenue is recognized or recorded when it becomes realized or realizable, and earned. According to the revenue recognition principle, revenue should not be recognized for work that is to be performed in subsequent accounting periods, even though the work might currently be under contract. In general, revenue should be recognized in the period in which the work is performed.
Assets, liabilities, and owner’s equity are all items that appear on a company’s balance sheet.
A. True
B. False
A. True
The balance sheet, or statement of financial position, shows a “snapshot” of a company’s financial situation at a specific point in time, generally the last day of the accounting period. The balance sheet is an expansion of the accounting equation, Assets = Liabilities + Owners’ Equity. That is, it lists a company’s assets on one side and its liabilities and owners’ equity on the other side.
If compliance with generally accepted accounting principles (GAAP) would be significantly more expensive than a different method that isn’t GAAP, use of an alternative method is permitted.
A. True
B. False
B. False
The question of when it is appropriate to stray from generally accepted accounting principles (GAAP) is a matter of professional judgment; there is no clear-cut set of circumstances that justify such a departure. However, the fact that complying with GAAP would be more expensive or would make the financial statements look weaker is not a reason to use a non-GAAP method of accounting for a transaction.
Chapman Inc. has always used the first-in, first-out (FIFO) inventory valuation method when calculating its cost of goods sold. This is also the standard inventory valuation method for other comparable entities in Chapman’s industry. Chapman’s controller wants to change to the weighted-average cost method because it will make Chapman’s net income appear much larger than FIFO valuation will. After several years of poor performance, management would love to boost the company’s appearance to potential investors. However, Chapman must continue to use the FIFO inventory valuation method. This is reflected in which of the qualitative characteristics of financial reporting?
A. Valuation
B. Comparability
C. Relevance
D. Going concern
B. Comparability
Users of financial statements base their decisions on comparisons between different entities and on similar information from a single entity for another reporting period. Comparability is the qualitative characteristic that enables users to identify and understand similarities and differences between such items. Consistency, although related to comparability, is not the same. Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities. Comparability is the goal; consistency helps to achieve that goal.
However, both comparability and consistency do not prohibit a change in an accounting principle previously employed. An entity’s management is permitted to change an accounting policy only if the change is required by a standard or interpretation or results in the financial statements providing more reliable and relevant information about the effects of transactions; other events; or conditions on the entity’s financial position, financial performance, or cash flows. The entity’s financial statements must include full disclosure of any such changes. Standards used to value inventory, depreciate assets, or accrue expenses should be consistent from one accounting period to the next. The desire to project an artificially strong performance is not a justifiable reason for a change in accounting principle. Since Chapman has always used FIFO, and since FIFO is the industry norm, a change to the weighted-average cost method is not justifiable.
Which of the following statements is TRUE with regard to the statement of cash flows?
A. The statement of cash flows shows a company’s financial position at a specific point in
time.
B. The statement of cash flows is often used in tandem with the income statement to determine a company’s true financial performance.
C. There are four types of cash flows: cash flows from operating activities, from investing activities, from financing activities, and from revenue activities.
D. The statement of cash flows is not always necessary because most companies operate under cash-basis accounting rather than accrual accounting.
B. The statement of cash flows is often used in tandem with the income statement to determine a company’s true financial performance.
The statement of cash flows reports a company’s sources and uses of cash during the accounting period. This statement is often used by potential investors and other interested parties in tandem with the income statement to determine a company’s true financial performance during the period being reported. The nature of accrual accounting allows (and often requires) the income statement to contain many noncash items and subjective estimates that make it difficult to fully and clearly interpret a company’s operating results. However, it is much harder to falsify the amount of cash that was received and paid during the year, so the statement of cash flows enhances the financial statements’ transparency.
The balance sheet shows a company’s financial position at a specific point in time.
Delta, a Certified Fraud Examiner, was hired to serve as an expert accounting witness in a case of alleged financial statement fraud. As part of her expert testimony, Delta explained how, under International Financial Reporting Standards, management must make every effort to ensure that the company’s financial statements are complete, neutral, and free from error. Delta was explaining the concept of:
A. Comparability
B. Going concern
C. Faithful representation
D. None of the above
C. Faithful representation
Financial information must faithfully represent the economic data of the enterprise that it purports to represent. Every effort shall be made to maximize the qualities of perfectly faithful representation: complete, neutral, and free from error. A complete depiction includes all information necessary to understand the data presented. Aneutral depiction is without bias in the selection or presentation of financial information. Free from error means there are no material errors or omissions in the financial reporting data, and the process used to produce the reported information has been selected and applied with no errors.
Which of the following appears on the balance sheet?
A. Revenues
B. Expenses
C. Cost of goods sold
D. Current assets
D. Current assets
The balance sheet, or statement of financial position, is an expansion of the accounting equation, Assets = Liabilities + Owners’ Equity. That is, it lists a company’s assets on one side and its liabilities and owners’ equity on the other side. Assets are classified as either current or noncurrent. Current assets consist of cash or other liquid assets that are expected to be converted to cash, sold, or used up, usually within a year or less. Current assets listed on the balance sheet include cash, accounts receivable, inventory, supplies, and prepaid expenses.
Revenues, expenses, and cost of goods sold are all items that appear on a company’s income statement.
At the end of each fiscal year, the accounts reflected on the income statement are reduced to a zero balance.
A. True
B. False
A. True
The accounts reflected on the income statement are temporary; at the end of each fiscal year, they are reduced to a zero balance (closed), with the resulting net income (or loss) added to (or subtracted from) retained earnings on the balance sheet.
In double-entry accounting, every transaction in the accounting records will have both a debit and a credit side, and these sides will always be equal.
A. True
B. False
A. True
Entries to the left side of an account are debits, and entries to the right side of an account are credits. Debits increase asset and expense accounts, while credits decrease them. Conversely, credits increase liability, owners’ equity, and revenue accounts; debits decrease them. Every transaction recorded in the accounting records will have both a debit and a credit, thus the term double-entry accounting. The debit side of an entry will always equal the credit side so that the accounting equation remains in balance.
According to the going concern disclosure requirements, if there is substantial doubt about a company’s ability to fulfill its financial obligations over a reasonable period of time, it must be disclosed in the company’s financial statements.
A. True
B. False
A. True
A company’s management is required to provide disclosures when existing events or conditions indicate that it is more likely than not that the entity might be unable to meet its obligations within a reasonable period of time after the financial statements are issued. There is an assumption that an entity will continue as a going concern; that is, the life of the entity will be long enough to fulfill its financial and legal obligations. Any evidence to the contrary must be reported in the entity’s financial statements.
David runs a local catering company. He keeps his books on a calendar year and uses the accrual basis of accounting. In December of Year 1, a customer placed an order with him to cater the food for a party that would take place in February of Year 2. The contract was signed and the balance was paid in full when the order was placed in December. When should David report the revenue from this party and the associated expenses of catering it?
A. It doesn’t matter; it is up to David to decide whether he reports the revenue and expenses in December or February.
B. The revenue should be recorded in December when David received the cash, and the expenses should be recorded in February after the party takes place.
C. Both the revenue and expenses should be recorded in December.
D. Both the revenue and expenses should be recorded in February.
D. Both the revenue and expenses should be recorded in February.
Expenses are recognized in the income statement on the basis of a direct association between the costs incurred and the earning of specific items of income. This process, commonly referred to as the matching principle, involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events; for example, the various components of expense making up the cost of goods sold are recognized at the same time as the income derived from the sale of the goods. In this example, since the expenses will not be incurred until David caters the event in February, the revenue David received should not be recorded until February as well.
Debits increase asset and liability accounts.
A. True
B. False
B. False
Entries to the left side of an account are referred to as debits, and entries to the right side of an account are referred to as credits. Debits increase asset and expense accounts, whereas credits decrease these accounts. On the other side of the equation, credits increase liabilities, revenue, and owners’ equity accounts. Conversely, debits decrease liabilities, revenues, and owners’ equity.
While debits do in fact increase assets, they reduce liabilities.
The ____________ details how much profit (or loss) a company earned over a particular period of time.
A. Statement of changes in owners’ equity
B. Balance sheet
C. Income statement
D. Statement of cash flows
C. Income statement
Whereas the balance sheet shows a company’s financial position at a specific point in time, the income statement, or statement of profit or loss and other comprehensive income, details how much profit (or loss) a company earned during a period of time, such as a quarter or a year.
The statement of changes in owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet.
The statement of cash flows reports a company’s sources and uses of cash during a particular period of time.
It is considered acceptable practice to deviate from generally accepted accounting principles (GAAP) in which of the following circumstances?
A. Adherence to GAAP would produce misleading results
B. It is common practice in the industry to give particular transactions a specific accounting treatment
C. There is concern that assets or income would be overstated
D. All of the above
D. All of the above
The question of when it is appropriate to stray from generally accepted accounting principles (GAAP) is a matter of professional judgment; there is no clear-cut set of circumstances that justify such a departure. It can be assumed that adherence to GAAP almost always results in financial statements that are fairly presented. However, the standard-setting bodies recognize that, upon occasion, there might be an unusual circumstance when the literal application of GAAP would render the financial statements misleading. In these cases, a departure from GAAP is the proper accounting treatment.
Departures from GAAP can be justified in the following circumstances:
It is common practice in the entity’s industry for a transaction to be reported a particular way.
The substance of the transaction is better reflected (and, therefore, the financial statements are more fairly presented) by not strictly following GAAP.
If a transaction is considered immaterial (i.e., it would not affect a decision made by a prudent reader of the financial statements), then it need not be reported.
There is concern that assets or income would be overstated (the conservatism constraint requires that when there is any doubt, one should avoid overstating assets and income).
The results of departure appear reasonable under the circumstances, especially when strict adherence to GAAP will produce unreasonable results and the departure is properly disclosed.
Which of the following statements is NOT true regarding the statement of changes in owners’ equity?
A. It shows how amounts on the income statement flow through to the balance sheet.
B. It serves a similar purpose to the statement of retained earnings.
C. It lists the major company shareholders and the change in their ownership equity over the fiscal year.
D. It acts as the connecting link between the balance sheet and the income statement.
C. It lists the major company shareholders and the change in their ownership equity over the fiscal year.
The statement of changes in owners’ equity details the changes in the total owners’ equity amount listed on the balance sheet. Because it shows how the amounts on the income statement flow through to the balance sheet, it acts as the connecting link between the two statements. The balance of the owners’ equity at the beginning of the year is the starting point for the statement. The transactions that affect owners’ equity are listed next and are added together. The result is added to (or subtracted from, if negative) the beginning-of-the-year balance, which provides the end-of-the-year balance for total owners’ equity.
The statement of changes in owners’ equity is a summary overview of the effects of owner investment and company net income on the owners’ equity balance. It does not name any shareholders or their individual ownership stake in the company.
Some companies present a statement of retained earnings rather than a statement of changes in owners’ equity. Similar to the statement of changes in owners’ equity, the statement of retained earnings starts with the retained earnings balance at the beginning of the year.
As a sale is made, the appropriate charges for cost of goods sold or other expenses directly corresponding to the sale should be recorded in the same accounting period.
A. True
B. False
A. True
Expenses are recognized in the income statement on the basis of a direct association between the costs incurred and the earning of specific items of income. This process, commonly referred to as the matching principle, involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events; for example, the various components of expense making up the cost of goods sold are recognized at the same time as the income derived from the sale of the goods.
Julia runs a printing company and has an antique printing press that she uses in her business. She purchased the press from a friend for $5,000. Similar presses are selling on the market today for about $8,000. Julia has a colleague who recently paid $9,000 for an antique printing press. According to the historical cost basis of asset measurement, how much should Julia initially record the printing press for on her books?
A. $8,000
B. $3,000
C. $5,000
D. $9,000
C. $5,000
According to the historical cost basis of asset measurement, assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. This basis is the one most commonly adopted by entities in preparing their financial statements. In this example, Julia should list the printing press on her balance sheet for the amount she originally purchased it for—$5,000.
Which of the following statements is TRUE regarding the balance sheet?
A. The accounts that appear on the balance sheet include revenues and expenses.
B. Balance sheets are usually manipulated by understating assets or overstating liabilities.
C. The balance sheet shows the financial performance of a company over a certain period of time, such as a quarter or a year.
D. Assets are generally presented on the balance sheet in order of liquidity.
D. Assets are generally presented on the balance sheet in order of liquidity.
The balance sheet, or statement of financial position, shows a “snapshot” of a company’s financial situation at a specific point in time, generally the last day of the accounting period. The balance sheet is an expansion of the accounting equation, Assets = Liabilities + Owners’ Equity. That is, it lists a company’s assets on one side and its liabilities and owners’ equity on the other side.
Assets are the resources owned by a company. Generally, assets are presented on the balance sheet in order of liquidity (i.e., how soon they are expected to be converted to cash).
Generally, in a financial statement fraud scheme, the balance sheet is manipulated to appear stronger by overstating assets and/or understating liabilities.
Entries to the left side of an account are referred to as credits, while entries to the right side of an account are debits.
A. True
B. False
B. False
Entries to the left side of an account are referred to as debits, and entries to the right side of an account are referred to as credits. Asset and expense accounts are increased with debits and decreased with credits, while liabilities, owners’ equity, and revenue accounts are increased with credits and decreased with debits.
