Chapter2FinancialAccountingandtheConceptualFramework

MultipleChoiceQuestions

1.D2.B3.D4.B5.A6.D7.A8.C9.B10.B11.C

DiscussionQuestions

1.Whatistheprimaryobjectiveoffinancialreporting?

Theobjectiveoffinancialreportingistoprovidefinancialinformationaboutthereportingentitythatisusefultopresentandpotentialequityinvestors,lenders,andothercreditorsinmakingdecisionsaboutprovidingresourcestotheentity.Thesedecisionsinvolvebuying,selling,orholdingequityanddebtinstruments,andprovidingorsettlingloansandotherformsofcredit.General-purposefinancialreportinghelpsuserswholacktheabilitytodemandallthefinancialinformationtheyneedfromanentityandthereforemustrely,atleastpartly,ontheinformationprovidedinfinancialreports.

2.Brieflydescribethetwofundamentalqualitiesofusefulaccountinginformation.

(Youmaychoosetwoofthefollowingqualitiesofusefulaccountinginformationtodescribe)

Thefundamentalqualitiesofusefulaccountinginformationincludereliability(faithfulrepresentation),relevance,comparability,consistency,timeliness,andunderstandability.

Specially,(1)Reliabilitymeansthatthenumbersanddescriptionsmatchwhatreallyexistedorhappened.Tobereliable,informationmustbecomplete,neutral,andfreeofmaterialerror.Reliabilityisanecessity,becausemostusershaveneitherthetimenortheexpertisetoevaluatetheactualcontentoftheinformation.(2)Relevance.Toberelevant,accountinginformationmustbecapableofmakingadifferenceinadecision.Relevantinformationhelpsuserspredicttheultimateoutcomeofpast,present,andfutureevents.(3)Comparability.Informationthatismeasuredandreportedinasimilarmannerfordifferentcompaniesisconsideredcomparable.Comparabilityenablesuserstoidentifytherealsimilaritiesanddifferencesineconomiceventsbetweencompaniesandbetweentimeperiods.(4)Consistency.Whenacompanyappliesthesameaccountingtreatmenttosimilarevents,fromperiodtoperiod,thecompanyshowsconsistentuseofaccountingstandards.(5)Timeliness.Timelinessmeanshavinginformationavailabletodecision-makersbeforeitlosesitscapacitytoinfluencedecisions.Havingrelevantinformationavailablesoonercanenhanceitscapacitytoinfluencedecisions,andalackoftimelinesscanrobinformationofitsusefulness.(6)Understandability.Understandabilityisthequalityofinformationthatletsreasonablyinformedusersseeitssignificance.

3.Whatarethefourbasicassumptionsthatunderliethefinancialaccountingstructure?

Thefourbasicassumptionsinclude(1)thebusinessentityassumption,(2)thegoing-concernassumption,(3)periodicityassumption,and(4)thestable-dollarassumption.

Specially,(1)thebusinessentityassumption.Thebusinessentityassumptionmeansthateconomicactivitycanbeidentifiedwithaparticularunitofaccountability.Itisrequiredthatthebusinessentityisaccountedforseparatelyfromtheindividualswhoownit.(2)Thegoing-concernassumption.Thegoing-concernassumptionmeansthatthecompanywillhaveanindefinitelife.Despitenumerousbusinessfailures,mostcompanieshaveafairlyhighcontinuancerate.Thegoing-concernassumptionappliesinnormalbusinesssituations.However,whenliquidationappearsimminent,theassumptionisnotapplicable.(3)Theperiodicityassumption.Theperiodicityassumptionimpliesthatacompanycandivideitseconomicactivitiesintoartificialandconsistenttimeperiods.Therearemanytimeperiods,normallyincludingmonthly,quarterly,andyearly.(4)Thestable-dollarassumption.AccountantsintheUnitedStatespreparefinancialstatementsunderanassumptionthatthedollarisastableunitofmeasurement.Thecostprincipleandthestable-dollarassumptionworkwellinperiodsofstablepricesbutarelesssatisfactoryundertheconditionofrapidinflation.

4.Whatisthebasicaccountingequation?Brieflydefinethethreebasicelementsintheequation.

TheBalanceSheetreportsassetsandclaimstoassetsataspecificpointintime.Claimstoassetsaresubdividedintotwocategories:claimsofcreditorsandclaimsofowners.Claimsofcreditorsarecalledliabilitiesandclaimsofownersarecalledowners’equity.Therelationshipamongassets,liabilities,andowners’equityis:

Assets=Liabilities+Owners’equity

Thisequationisreferredtoasthebasicaccountingequation.Assetsmustbalancewiththeclaimstoassets.Therefore:

Assets-Liabilities=Owners’equity

Assetsareeconomicresourcesthatareownedorcontrolledbyaparticularentityandareexpectedtobenefitfutureoperations.Liabilitiesarefinancialobligationsordebts.Theyrepresentnegativefuturecashflowsfortheenterprise.Owners’equityrepresentstheowners’claimsontheassetsofthebusiness.Becauseliabilitiesorcreditors’claimshavelegalpriorityoverthoseoftheowners,owners’equityisaresidualamount.Owners’equityalwaysequalstotalassetsminustotalliabilitiesandhenceisthenet(book)valueoftheentity.

5.Giveanexampleofbusinesstransactionsthatwould:

(1)causeoneassettoincreaseandanotherassettodecrease,withnoeffectoneitherliabilitiesorowners’equity.

OnJan.8,2021,CompanyABCboughtofficeequipmentatacostof$3,000.Paidcash.

(2)causebothtotalassetsandliabilitiestoincreasewithnoeffectonowners’equity.

OnJan.12,companyABCboughtmaterialsoncreditfor$3,000(30-dayopenaccount).

6.Whatismeantbythetermfulldisclosure,andhowdoaccountantsfulfillthisrequirementoffinancialstatements?

Indecidingwhatinformationtoreport,companiesfollowthegeneralpracticeofprovidinginformationthatisofsufficientimportancetoinfluencethejudgmentanddecisionsofaninformeduser.Fulldisclosureprinciplerecognizesthatthenatureandamountofinformationincludedinfinancialreportsreflectaseriesofjudgmentaltrade-offs.Thesetrade-offsstrivefor(1)sufficientdetailstodisclosemattersthatmakeadifferencetousers,yet(2)sufficientsummarizationstomaketheinformationunderstandable,keepinginmindthecostsofpreparingitandthebenefitsofusingit.

Fulldisclosureismadeinthebodyoffinancialstatementsandinnotestothesestatements.Thenotestothefinancialstatementsgenerallyamplifyorexplaintheitemspresentedinthemainbodyofthestatements.

7.Whatistheaccountingcycle?Brieflyexplaintheeightstepsoftheaccountingcycle.

Accountingcycleisthesequenceofaccountingproceduresusedtorecord,classify,andsummarizeaccountinginformationinfinancialreportsatregularintervals.Theaccountingcyclebeginswiththeinitialrecordingofbusinesstransactionsandconcludeswiththepreparationofacompletesetofformalfinancialstatements.

Theaccountingcyclegenerallyconsistsofeightspecificsteps:

(1)Identifyingandrecordingbusinesstransactionsandevents:Anitemshouldberecognizedinthefinancialstatementsifitisanelement,ismeasurable,andisrelevantandreliable.

(2)Journalizing:Companiesrecordtransactionsandeventinjournals.

(3)Postingtotheledger:Postingistheprocedureoftransferringjournalentriestotheledgeraccounts.Itinvolvescopyingtheinformationthathasalreadybeenrecordedinthejournalsintotheledgeraccounts.

(4)PreparingaTrialBalance:AcompanyusuallypreparesaTrialBalanceattheendofanaccountingperiodtoprovetheequalityofdebitandcreditbalances.TheTrialBalanceliststheaccountsintheordertheyappearintheledger,withdebitbalanceslistedintheleftcolumnsandcreditbalancesintherightcolumn.Thetotalsofthetwocolumnsmustagree.

(5)Adjustingentries:adjustingentriesareneededattheendofeachaccountingperiodtomakecertainthatappropriateamountsofrevenueandexpensearereportedinthecompany’sIncomeStatement.Adjustingentriesareclassifiedaseitherdeferralsoraccruals.Deferralsincludeprepaidexpensesandunearnedrevenues,andaccrualsincludeaccruedrevenuesandaccruedexpenses.

(6)PreparinganAdjustedTrialBalance:Aftertheadjustmentsarepostedtotheledger,acompanyneedstoprepareanadjustedTrialBalance.

(7)Preparingthefinancialstatements:CompaniescanpreparefinancialstatementsdirectlyfromanAdjustedTrialBalanceonceithasbeendeemedtobeaccurate.TheIncomeStatementispreparedfirstbecauseitdeterminestheamountofnetincometobereportedintheStatementofRetainedEarnings.TheStatementofRetainedEarningsispreparedsecondbecauseitdeterminestheamountofretainedearningstobereportedintheBalanceSheet.

(8)Closingthebooks:Attheendofanaccountingperiod,thechangesinretainedearningsaccumulatedinthesetemporaryaccountsaretransferredintothepermanent,owners’equityaccountRetainedEarningsthroughthepreparationofclosingentries.Theclosingprocessinvolvesfoursteps:(1)ClosingallrevenueaccountstotheIncomeSummary;(2)ClosingallexpenseaccountstotheIncomeSummary;(3)ClosingtheIncomeSummarytoRetainedEarnings;and(4)ClosingDividendsaccounttoRetainedEarnings.

8.WhatistheroleofaTrialBalanceandwhatarethelimitationsofaTrialBalance?

AcompanyusuallypreparesaTrialBalanceattheendofanaccountingperiodtoprovetheequalityofdebitandcreditbalances.TheTrialBalanceliststheaccountsintheordertheyappearintheledger,withdebitbalanceslistedintheleftcolumnsandcreditbalancesintherightcolumn.Thetotalsofthetwocolumnsmustagree.ATrialBalancealsouncoverserrorsinjournalizingandposting.Inaddition,itisusefulinthepreparationoffinancialstatements.ATrialBalanceisapreliminaryBalanceSheetdonetolookforerrors.

However,notallerrorscanbefoundbyusingaTrialBalance.ManyerrorsexisteventhoughtheTrialBalancecolumnsagree.Forexample,theTrialBalancemaybalanceevenwhenacompany(1)failstojournalizeatransaction,(2)omitstopostacorrectjournalentry,(3)postsajournalentrytwice,(4)usesincorrectaccountsinjournalizingorposting,(5)makesoffsettingerrorsinrecordingtheamountofatransaction.Inotherwords,aslongasacompanypostsequaldebitsandcredits,eventothewrongaccountorinthewrongamount,thetotaldebitswillequalthetotalcredits.TheTrialBalanceprovesonlyoneaspectoftheledger,andthatistheequalityofdebitsandcredits.Nevertheless,despitetheselimitations,theTrialBalanceisausefulscreenforfindingerrorsandisfrequentlyusedinpractice.

9.Whataretheadjustingentries?Brieflyexplainthefourcategoriesofadjustingentries.

Attheendofeachaccountingperiodadjustingentriesarepreparedtomakecertainthatappropriateamountsofrevenueandexpensearereportedinthecompany’sIncomeStatement.

Adjustingentriesareclassifiedaseitherdeferralsoraccruals.Deferralsinclude(1)prepaidexpenses,theexpensesthatarepaidincashandrecordedasassetsbeforetheyareusedorconsumed.Theprepaidexpenseadjustingentryconsistsofadebittoanexpenseaccountandacredittoanassetaccount(orcontra-assetaccount);(2)unearnedrevenues,therevenuesthatarereceivedincashandrecordedasliabilitiesbeforetheyareearned.Theadjustingentryforunearnedrevenuesconsistsofadebittoaliabilityaccount(unearnedrevenue)andacredittoarevenueaccount.

Accrualsinclude(1)accruedrevenues,therevenuesthatareearnedbutnotyetreceivedincashnorrecorded.Date.Anyaccruedrevenueshouldberecordedattheendoftheaccountingperiodbymeansofanadjustingentry;(2)accruedexpenses,theexpensesthatareincurredbutnotyetpaidincashnorrecorded.Attheendoftheaccountingperiod,anadjustingentryshouldbemadetorecordanyexpensesthathaveaccruedbuthavenotyetbeenrecorded.

10.Whatistheprocessofclosingentries?Brieflyexplainthefourstepsofclosingprocess.

Attheendofanaccountingperiod,thechangesinretainedearningsaccumulatedinthesetemporaryaccountsaretransferredintothepermanent,owners’equityaccountRetainedEarningsthroughthepreparationofclosingentries.Thejournalentriesmadeforthepurposeofclosingthetemporaryaccountsarecalledclosingentries.Thisprocessofclosingreturnsthebalancesofthetemporaryaccountstozero,sothattheyarereadyformeasuringrevenues,expenses,anddividendsofthenextaccountingperiodseparatefromthedatainthepriorperiods.

Theclosingprocessinvolvesfoursteps:

(1)ClosingallrevenueaccountstotheIncomeSummary.

(2)ClosingallexpenseaccountstotheIncomeSummary.

(3)ClosingtheIncomeSummarytoRetainedEarnings.

(4)ClosingDividendsaccounttoRetainedEarnings.

Problems

Problem2-1

InJanuary,thefollowingtransactionswerecarriedoutbycompanyABC:

1.Soldcapitalshocktoownersfor$10,000.

Jan.XX

Cash

10,000

CapitalStock

10,000

Soldstockforcash.

2.Purchasedlandandasmallofficebuildingforatotalpriceof$50,000,ofwhich$20,000wasthevalueofthelandand$30,000wasthevalueofthebuilding.Paid$10,000incashandsignedanotepayablefortheremaining$40,000.

Jan.XX

Land

Officebuilding

20,000

30,000

Cash

10,000

AccountsPayable

40,000

Purchasedland($20,000)andasmallofficebuilding(S30,000).Paid$10,000incashandsignedanotepayablefortheremaining$40,000.

3.Boughtseveralcomputersystemsoncreditfor$6,000(30-dayopen