Chapter 1: Environment and Theoretical Structure of Financial Accounting

Your most challenging concepts

- List providers of financial information - Summarize the role of financial accounting - Recall the wording of an unqualified or clean audit opinion

The objectives of financial accounting include

- Provide information to investors and creditors - Provide information used to evaluate future cash flows

Revenue should be recognized when the seller satisfies its performance obligation(s) to its customers. What is the accounting issue if the revenue recognition rule is not followed?

- The income statement would not report the accomplishments of the period. - Net income may be overstated or understated for the period.

What classification would the following auditor opinion receive? "In our opinion, the consolidated financial statements listed in the accompanying index present fairly...in conformity with U.S. GAAP."

- a clean opinion

Which of the following instances indicate net operating cash flow may not be a good predictor of long-run-cash-generating ability?

- a company pays cash to purchase a 2 year insurance policy - a customer pays for services provided in a prior period

Expense recognition is implemented by which of the following ways?

- cause-and-effect relationship. - in the period incurred - systematic and rational allocation. - associating expenses and revenues in a specific period of time.

Why is accounting standard setting a political process?

- changes in standards can result in a substantial redistribution of wealth within our economy - standards can have significant effects on companies, investors, and creditors

In developing standards, the FASB considers the:

- concerns and opinions of constituents - economic transactions that standards will address

according to the conceptual framework, for accounting information to be relevant, what qualities must it possess?

- confirmatory value - predictive value

Which of the following items qualify for the fair value option?

- financial assets - financial liabilities

Which of the following are providers of financial information?

- households - schools - companies

What organizations provide financial information to external users?

- profit-oriented businesses - charitable organizations

To be useful for decision making, information should possess the fundamental decision-specific qualities of

- relevance - faithful representation

The involvement of accounting professionals and management in accounting scandals resulted in Congress passing the Sarbanes-Oxley Act?

- require CEO accountability - provide penalties for violators - prevent conflicts of interests - regulate auditors

Financial Accounting provides investors with information that should help them to evaluate the:

- the timing of the firm's future cash flow - uncertainty of the firm's future cash flow - amounts of the firm's future cash flow

What information regarding an entity's future cash flows are investors and lenders interested in?

- uncertainty - timing - amount

Financial accounting provides investors with information that should help them to evaluate the

- uncertainty of the firm's future cash flow - timing of the firm's future cash flow - amounts of the firm's future cash flow

Before issuing an Accounting Standards Update, the FASB undertakes a series of information-gathering steps including

- written comments - deliberations - open hearings

Without regard to related revenue in the period incurred

Advertising expenditures

If a company elects the fair value option for a financial asset or financial liability, how are the changes in fair value reported in the financial statements?

As gains or losses on the income statement

Who has the responsibility for preparing financial statements in accordance with generally accepted accounting principles?

Corporate management

Cause-and-effect relationship

Cost of goods sold

Under the accrual accounting model, the measure of resources sacrificed is called

Expense

True or False: Net operating cash flow is a good indicator of a company's long-run cash-generating ability

False, sometimes cash is exchanged in one period that relates to multiple periods so net operating cash flow is not necessarily a good indicator of a company's long-run cash-generating ability

True or false: Net operating cash flow is a good indicator of a company's long-run cash-generating ability

False, sometimes cash is exchanged in one period that relates to multiple periods so net operating cash flow is not necessarily a good indicator of a company's long-run cash-generating ability

The ______ principle requires that any information useful to decision makers be provided in the financial statements, subject to the cost effectiveness constraint

Full disclosure

What are the costs of providing financial information?

Gathering, processing, and disseminating information.

Who has the responsibility to appropriately apply GAAP when preparing financial statements?

Management

Specific time period

Monthly salary payments to an office employee

What is net operating cash flow?

The difference between cash receipts and cash disbursements from providing goods and services during a period

True or False: Capital markets foster the efficient allocation of resources

True

True or false: Both profit-oriented companies and not-for-profit companies are providers of financial information

True

True or false: Political pressure has deterred the FASB from issuing particular standard changes

True

True or false: The FASB considers written comments from interested parties before issuing an Accounting Standards Update

True, the FASB has an extensive due process including open hearings, deliberations, and written comments

The concept of understandability assumes that the users of financial statements should have

a reasonable understanding of business and economic activities.

Accounting information meets the qualitative characteristic of consistency if it is measured and reported the same way

across different reporting periods

The historical cost of an asset is the _______

amount of consideration given for the asset at initial acquisition.

Financial assets and liabilities can be reported

at fair value or historical cost

Who serves as an independent intermediary to help ensure that management has appropriately applied GAAP in preparing the financial statements?

auditors

The accrual accounting model measures the entity's accomplishments and resource sacrifices during the period regardless of when ___________ is received or paid

cash

an enhancing qualitative characteristic of accounting information that allows users to better understand similarities and difference in the financial reports across different companies is called

comparability

if the same accounting principles and methods are used for similar events by two different firms, this enhances what accounting qualitative characteristic?

comparability

enhancing qualitative characteristics

comparability, consistency, verifiability, timeliness, and understandability

Accounting information is __________ if similar items are treated the same way among various companies highlighting similarities and differences between events and conditions

comparable

faithful representation

completeness, neutrality, and freedom from material error

Before they can be recognized, favorable items tend to require more verification than unfavorable items. Accountants refer to this as

conservatism

Before they can be recognized, favorable items tend to require more verification than unfavorable items. Accountants refer to this as ___________

conservatism

the tendency to recognize unfavorable items more quickly than favorable items is referred to as ___________

conservatism or conservative

the qualitative characteristic of using the same accounting method each period over time refers to the concept of ___________

consistency or comparability

The Sarbanes-Oxley Act increases accountability of who?

corporate executives

constraints

cost effectiveness

The full-disclosure principle requires that financial reports should include any information that could affect the decisions made by external users, within the constraint that the benefits of that information should exceed the ______ of providing information

costs

The process of including additional pertinent information in the financial statements and accompanying notes is referred to as _________

disclosure

The requirement that the economic activities of a business owner should be separated from the activities of the business is an example of which accounting assumption?

economic entity

An essential assumption in accounting is that all economic events can be identified specifically with an individual economic __________

entity

For information to be cost effective, the perceived benefit of increased decision usefulness must

exceed the anticipated costs of providing that information.

Expense recognition often matches _________ and ________ that arise from the same transaction

expenses revenues

Any information useful to decision makers should be provided in the financial statements, subject to the cost effectiveness constraint. This describes which accounting principle?

full-disclosure principle

The assumption that a business entity will continue to operate indefinitely in the future refers to what assumption?

going concern

Measuring assets and liabilities based on their original transaction value is an example of _______

historical cost

The principle stating that asset and liability measurements should be based on the amount given or received in the original transaction is referred to as the

historical cost

Claire's revenues are greater than her expenses. Claire has net _______ for the period

income

The going concern assumption is critical to the measurement of assets because if a business were going to cease operations, its assets would be measured at their _________

liquidation values

Who has the responsibility to appropriately apply GAAP when preparing financial statements?

management

Expenses are ______ to revenues from the same transaction.

matched

Predictive value, confirmatory value, and _________ all relate to the fundamental characteristic of relevance in financial information

materiality

The process of associating numerical amounts to the elements in the financial statements is called ________

measurement

The process of associating numerical amounts to the elements of the financial statements is referred to as __________

measurement

Which accounting assumption states that financial statement elements should be measured in terms of the United States dollar for U.S financial reporting?

monetary unit

The difference between revenue and expenses when expenses are greater is called

net loss

the characteristic that a new accounting standard should not favor one group of companies over others or achieve a particular social outcome is an example of

neutrality

which qualitative characteristic requires that financial information should not influence decision making to achieve a predetermined result?

neutrality

An advantage of historical cost measurement is that it is

objective and verifiable

Auditors examine financial statements to express a professional, independent _________ on the financial statements

opinion

Revenue recognition criteria are designed to prevent companies from __________ income in one period and, consequently, ___________ income in another period.

overstating understating

Which assumption allows the life of the company to be divided into artificial time periods to provide timely information?

periodicity

relevance

predictive value and confirmatory value

Cash-basis accounting:

produces a measure called net operating cash flow

The method for determining if an item is material and requires separate disclosure relies on

professional judgement

the method for determining if an item is material and requires separate disclosure relies on

professional judgement

The primary purpose of financial reporting is to provide useful information for decision making to

providers of capital

The process of admitting information into the financial statements is referred to as ________

recognition

Recognition refers to the process of

recording information in the basic financial statements.

The hierarchy of qualitative characteristics of financial information require that, in order to be useful for decision making, information should possess the fundamental characteristics of

relevance and faithful representation

The accrual accounting model's measure of resources provided by business operations is called

revenues

The difference between revenues and expenses is net income, or net less if expenses are greater than

revenues

Net income is the difference between

revenues and expenses

Cash-basis accounting measures

the difference between cash receipts and payments during a reporting period

faithful representation exists when

there is agreement between a measure or description and the phenomenon it purports to represent

The periodicity assumption relates to which qualitative characteristic?

timeliness

The accounting characteristic that requires a user to comprehend the information within the context of the decision being made is referred to as

understandability

An _______________ opinion signals that a company's financial statements do not contain material departures from US GAAP.

unqualified, clean, or unmodified

When the cost of an item can be traced to objective evidence of a transaction, such as a sales receipt, canceled check, and bank statement, the information has the quality of __________

verifiability

a consensus among different individuals appraising the value of land describes which qualitative accounting characteristic?

verifiability

Information is ________ if different independent measures would reach consensus about whether it is representationally faithful.

verifiable