Assumptions, Accounting Principles

Question 1

Entity Assumptions

Answer 1

We assume there is a separate accounting entity for each business organization. For example, the owners and the corporation are separate.

Question 2

Going Concern Assumption

Answer 2

1. ) Unless there is information to the contrary, a business is assumed to have an indefinite life, that is, it will be a going concern.
2. ) Also called the continuity assumptions, supports the hisorical cost principle for many assets. Income measurement is based on historical cost of assets because assets provide value through use, rather than disposal. Therefore, net income is the difference between revenue and the historical cost of assets used in generating that revenue.

Question 3

Unit of Measure-Assumptions

Answer 3

Assets, Liabilites, Equities, Revenues, expenses, gains, losses and cash flows are measured in terms of the monetary value of the country in which the business is operated.

Question 4

What is the capital maintenance assumption?

Answer 4

Related to the unit of measure assumption. Capital is said to be maintained when the firm has positive earnings for the year, assuming no change in price levels. When a firm has income it has sufficient revenue to replace all the resources used in generating that revenue (return of capital), and has resources left over in additions (income, which is return on capital). GAAP is based on the concept of financial capital maintenance.

Question 5

What is “Physical Capital Maintenance” assumption?

Answer 5

Says that earnings cannot be recognized until the firm has provided for the capital used up during the period.

Question 6

What is the time period assumption?

Answer 6

The life of a business is broken down into periods, typically a year, for reporting purposes. The use of estimates is required for timely reporting, but also implies a possible loss of reliability.

Question 7

What is the historical cost Principle?

Answer 7

Assets and liabilities are recorded at their cash equivalent at time of origination. This value is the market value of the item at date of acquisition. Given the going concern assumption, revaluation to market value is inappropriate for PPE, because the value of these assets is derived through use, rather than disposal.

Question 8

What is the net realizable value principle?

Answer 8

This is used to approximate liquidation value or selling price. Example - Lower cost or maker for inventory valuation used NRV

Question 9

What is the current replacement cost principle?

Answer 9

This represents how much you would have to pay to replace an asset. This replacement cost would represent current Market Value. Example - used in inventory valuation

Question 10

What is the “Current Market Value” Principle?

Answer 10

Also referred to as Fair Value. It is the price that would be received to sell an asset (or price to settle a liability) in an orderly transaction between market participants. Example - CMV is used to value trading and available for sale securities.

Question 11

What is the “Amortized Cost” Principle?

Answer 11

Historical Cost minus the accumulated amortization or depreciation of the asset. Example - Buildings are reported at historical cost minus accumulated depreciation.

Question 12

What is the “Net Present Value” Principle?

Answer 12

Value determined from discounting the expected future cash flows. Example - Discounted future cash flows are used in many capital budgeting decisions..

Question 13

What 3 issues does the Revenue Recognition Principle address?

Answer 13

1. ) Defines Revenue
2. ) When to Recognize Revenue
3. ) How to measure revenue

Question 14

How is “Revenue” defined?

Answer 14

Increases in assets or the extinguishment of liabilities stemming from the delivery of goods or the provision of services

Question 15

When to recognize revenue?

Answer 15

Revenue are recognized when they are realized.

Question 16

What 3 conditions must be met for Revenue to be realized in a period?

Answer 16

1. ) Goods or services have been provided
2. ) Collectibility of cash is assured - revenue is realizable
3. ) Expenses of providing goods and services can be determined.

Question 17

How is Revenue Measured?

Answer 17

They are measured at the cash equivalent amount of the good or services provided.

Question 18

What is the “Matching Principle”?

Answer 18

Says Recognize expenses only when expenditures help to produce revenues. Revenues and expenses are “matched” to determine net income or loss.

Question 19

How are expenses reported if they are not direcly applicable to a revenue?

Answer 19

They are allocated based on the time period of benefit provided. Depreciation and Amortization are examples.

Question 20

What is the “Full Disclosure” principle?

Answer 20

Says that Financial Statements should present all information need by an informed reader to make an economic decision.

Question 21

Why is income measurement based on historical cost of assets?

Answer 21

Because assets provide value through use, rather than disposal

Question 22

What are the 4 accounting assumptions?

Answer 22

1. ) entity
2. ) going concern
3. ) unit of measurement
4. ) time period

Question 23

What are the 4 accounting principles?

Answer 23

1. ) revenue recognition
2. ) expense recognition (matching)
3. ) measurement
4. ) full disclosure