Chapter 2 Qualities of Accounting
Busy Beaver had revenues of $2,000, cost of goods sold of $780, advertising expense of $100, and interest expense of $25. Net income was ________.
$1,095
For June, Team Shirts had a beginning balance in its Retained earnings account of $500. Net income for the month was $875. Team Shirts paid dividends of $200. The ending balance in Retained earnings was ________.
$1,175
Busy Beaver had revenues of $2,000, cost of goods sold of $780, advertising expense of $100, and interest expense of $25. Gross profit was ________.
$1,220
Ace Electronics bought a new factory for $5,000,000. The factory was originally offered for sale for $5,200,000, but Ace successfully negotiated a lower price. Acme, Inc. was also trying to buy the factory and offered to pay $4,900,000. Ace should record the factory on its books at ________.
$5,000,000
Financial statements may be prepared ________.
All of these are correct
Explain the differences between accruals and deferrals.
An accrual is a transaction in which the revenue is earned, or the expense is incurred, before the exchange of cash. An example would be a sale on account. The account receivable is an accrual. A deferral is a transaction in which the exchange of cash takes place before the revenue is earned, or the expense is incurred. An example would be prepaid rent.
Explain the differences between cash-basis and accrual accounting.
Cash-basis accounting is a system based on the exchange of cash. In this system, revenue is recognized only when cash is collected, and an expense is recognized only when cash is disbursed. Cash-basis accounting is not an acceptable method under GAAP
Accrual accounting is an accounting system in which the measurement of income is based on cash receipts and cash disbursements.
FALSE
Cash-basis accounting is the preferred method of accounting according to the FASB.
FALSE
Comparability means that companies should use the same accounting rules from period to period.
FALSE
IFRS and U.S. GAAP are the same in all respects.
FALSE
Revenue minus expenses equals gross profit.
FALSE
The Financial Accounting Standards Board sets international financial reporting standards (IFRS).
FALSE
The IRS developed GAAP, or generally accepted accounting principles, for the accounting profession.
FALSE
U.S. generally accepted accounting principles (GAAP) are determined by the ________.
FASB
The set of rules that a U.S. company must follow when preparing its financial statements is called ________.
GAAP
It requires more judgment to use ________ than to use ________.
IFRS; U.S. GAAP
________ are more concept-based than ________.
IFRS; U.S. GAAP
What is profit?
Profit is the amount remaining after all the expenses of doing business are deducted from all the revenues for a specific period.
Team Shirts ordered T-shirts from its supplier in June. The T-shirts were delivered in July. Team Shirts paid the bill in August and sold the T-shirts in September. When should Team Shirts recognize an expense using accrual accounting?
September
An accrual transaction is one in which revenue is earned before cash is received
TRUE
An example of a corrective control is requiring that on a regular basis management must follow up on all errors and irregularities identified.
TRUE
An example of a detective control is requiring that the cash drawer be compared with the sales recorded by the register
TRUE
An example of a preventive control is requiring that all purchases over $1,000 be authorized by upper management.
TRUE
Financial statements should be prepared using accrual accounting.
TRUE
For information to be useful, it must be relevant and reliable.
TRUE
GAAP, or generally accepted accounting principles, are the rules for preparing financial statements followed by the accounting profession in the United States.
TRUE
IFRS have fewer detailed rules than U.S. GAAP.
TRUE
If a company spends $25 on copy paper, the amount is not material compared with the total office supplies budget of $250,000.
TRUE
Information that is relevant is both timely and useful in predicting the future.
TRUE
Internal controls are the policies and procedures managers of a firm use to protect the firm's assets and to ensure the accuracy and reliability of the firm's accounting records.
TRUE
On April 25, Team Shirts paid $1,000 for advertising for May and June. This transaction is a deferral
TRUE
Reliable information can be verified.
TRUE
Revenue minus expenses equals net income.
TRUE
The FASB, or Financial Accounting Standards Board, is currently the standards-setting body for rules that U.S. publicly-held companies must use in preparing financial statements.
TRUE
The current ratio measures a company's ability to pay its bills.
TRUE
The owner of a sole proprietorship should not include personal financial records as part of the financial records and statements of the business.
TRUE
The separate-entity concept means that a company and its owners should keep separate records.
TRUE
Two characteristics of useful information are comparability and consistency.
TRUE
Which of the following statements is TRUE?
The FASB determines U.S. generally accepted accounting principles.
What is the purpose of generally accepted accounting principles (GAAP)?
The purpose of financial reporting is to provide information for decision making. In order for financial information to be useful for evaluating the performance of a business, reporting rules must be uniform and applied in a consistent manner. Generally accepted accounting principles, or GAAP, are the set of rules that accountants and companies must follow when preparing financial statements
________ have more detailed rules than ________.
U.S. GAAP; IFRS
________ is more rule-based than ________.
U.S. GAAP; IFRS
Prepaid insurance is ________.
a deferral
Comparable information ________.
allows users to make comparisons across financial statements
Accounts payable represents ________.
amounts owed by the company to suppliers
Accounts receivable represents ________.
amounts owed to the company by customers
Liabilities are ________.
amounts that the business owes
An account receivable is ________.
an accrual
The going-concern assumption refers to ________.
an assumption is made that a company will continue to be in business in the future
Generally accepted accounting principles (GAAP) ________.
are a set of rules that a U.S. company must follow when preparing its financial statements
The economic resources of a company resulting from past transactions are called ________.
assets
The three basic elements of the balance sheet are ________.
assets, liabilities, and shareholders' equity
Adjusting the books is done ________.
at the end of every accounting period
Detective controls include ________.
bank reconciliations (comparing the company's accounting records for cash to its bank statement)
Reliable information ________.
can be verified as accurate and truthful
A deferral transaction is one in which ________.
cash comes before the action
Characteristics of useful information include ________.
comparability and consistency
An accountant discovered a bank error while reviewing the bank statement, and called the bank to correct the mistake. This call is an example of a ________.
corrective control
Denying future credit to customers who are slow to pay their accounts is called a ________.
corrective control
The accountant called the bank after noticing that a $200 deposit made on July 21 did not appear on the July 31 bank statement. This call is an example of a ________.
corrective control
Accounts receivable are classified as ________.
current assets
A classified balance sheet shows subtotals for ________.
current assets, long-term assets, current liabilities, long-term liabilities and shareholders' equity
Accounts payable are classified as ________.
current liabilities
Corrective controls are ________.
designed to identify when an error or irregularity has occurred
Detective controls are ________.
designed to identify when an error or irregularity has occurred
Preventive controls are ________.
designed to stop a problem before it starts
The SEC has ________.
established a time table for the convergence of U.S. GAAP and IFRS
Cash is ________.
found on the balance sheet
The set of rules that a U.S. company must follow when preparing its financial statements is called ________.
generally accepted accounting principles
The accounting rule which assumes that Team Shirts is continuing in business for an indefinite period of time is the ________.
going-concern assumption
Assets are recorded at their original cost to the company at the time of purchase. This is the ________ principle.
historical-cost
The first financial statement to be prepared at the end of each accounting period is the ________.
income statement
The four basic financial statements are the ________.
income statement, balance sheet, statement of changes in shareholders' equity, and statement of cash flows
Consistent information ________.
is presented the same way period after period
A financial statement provides information that ________.
is specific to a business enterprise
Preventive controls include ________.
limiting access to assets
The current ratio measures the ________.
liquidity of a company
Expenses are reported on the income statement when the related revenue is recognized. This is the ________ principle
matching
Supplies expense on the Team Shirts' income statement represents only supplies that were used to earn revenue during the accounting period. The accounting rule that applies is the ________.
matching principle
Accrual accounting is an accounting system in which ________.
measurement of income is NOT based on cash receipts and cash disbursements
Liquidity ________.
measures how easily a company can pay its debts as they come due
The historical-cost principle refers to ________.
measuring financial statement items at their cost at the time of the transaction
All of Team Shirts' financial statements are presented in U.S. dollars. The accounting rule that applies is the ________.
monetary-unit assumption
Team Shirts purchased $2,000 worth of T-shirts from a company in Guatemala. Team Shirts recorded the value of the transaction in U.S. dollars. Which accounting rule applies to this situation?
monetary-unit assumption
Relevant information ________.
needs to be current so it can be used to make decisions
The three basic elements of the statement of cash flows are ________.
operating activities, investing activities, and financing activities
Contributed capital is also called ________.
paid-in capital
Internal controls are ________.
policies and procedures the managers of a firm use to protect a firm's assets and the accuracy of its accounting records
Corrective controls include ________.
procedures for handling any errors that are detected
Which of the following is an example of using the materiality concept?
recording insignificant purchases as expenses even though technically they are considered assets
Equity ________.
represents shareholders' claims to the assets of a business
Clean Sweep performed cleaning services and billed the customer for $900. This transaction includes ________.
revenue and an account receivable
Net income equals ________.
revenue minus expenses
The revenue reported on the Team Shirts' income statement has been earned during the accounting period. The accounting rule that applies is the ________.
revenue-recognition principle
The three basic elements of the income statement are ________.
revenues, expenses, and net income or loss
Gross profit equals ________.
sales minus cost of goods sold
The accounting rule which requires that only the business transactions of Team Shirts be shown on the balance sheet is the ________.
separate-entity assumption
An accrual transaction is one in which ________.
the action comes before the cash
The monetary-unit assumption refers to ________.
the use of monetary units, such as dollars, to measure the value of financial statement amounts