Chapter 1

For each of the following situations, (1) indicate whether you agree or disagree with the financial reporting practice employed and (2) state the accounting concept that is applied (if you agree), or violated (if you disagree). 1) Winderl Corporation did not disclose that it was the defendant in a material lawsuit because the trial was still in progress. 2) Alliant Semiconductor Corporation files quarterly and annual financial statements with the SEC. 3) Reliant Pharmaceutical paid rent on its office building for the next two years and charged the entire expenditure to rent expense. 4) Rockville Engineering records revenue only after products have been shipped, even though customers pay Rockville 50% of the sales price in advance.

1) Disagree, The full disclosure principle 2) Agree, The periodicity assumption 3) Disagree, Expense recognition 4) Agree, Revenue recognition

Identify the accounting concept that was violated in each of the following situations. 1) Astro Turf Company recognizes an expense, cost of goods sold, in the period the product is manufactured. 2) McCloud Drug Company owns a patent that it purchased three years ago for $2 million. The controller recently revalued the patent to its approximate market value of $8 million. 3) Philips Company pays the monthly mortgage on the home of its president, Larry Crosswhite, and charges the expenditure to miscellaneous expense.

1) Expense recognition 2) The historical cost (original transaction value) principle 3) The economic entity assumption

Answer each of the following questions related to these characteristics and constraints. 1) Which component would allow a large company to record the purchase of a $120 printer as an expense rather than capitalizing the printer as an asset? 2) Donald Kirk, former chairman of the FASB, once noted that ". . . there must be public confidence that the standard-setting system is credible, that selection of board members is based on merit and not the influence of special interests . . ." Which characteristic is implicit in Mr. Kirk's statement? 3) Allied Appliances, Inc., changed its revenue recognition policies. Which characteristic is jeopardized by this change? 4) National Bancorp, a publicly traded company, files quarterly and annual financial statements with the SEC. Which characteristic is relevant to the timing of these periodic filings?

1) Materiality 2) Neutrality 3) Consistency 4) Timeliness

Identify the accounting concept that relates to each statement or phrase below. 1) Inflation causes a violation of this assumption. 2) Information that could affect decision making should be reported. 3) Recognizing expenses in the period they were incurred to produce revenue. 4) The basis for measurement of many assets and liabilities. 5) Relates to the qualitative characteristic of timeliness.

1) Monetary unit assumption 2) Full-disclosure principle 3) Expense recognition 4) Historical cost principle 5) Periodicity assumption

Identify the accounting concept that was violated in each of the following situations. 1) Pastel Paint Company purchased land two years ago at a price of $250,000. Because the value of the land has appreciated to $400,000, the company has valued the land at $400,000 in its most recent balance sheet. 2) Atwell Corporation has not prepared financial statements for external users for over three years. 3) The Klingon Company sells farm machinery. Revenue from a large order of machinery from a new buyer was recorded the day the order was received.

1) The historical cost (original transaction value) principle 2) The periodicity assumption 3) Revenue recognition

For each of the following items, identify the appropriate financial statement element: 1) Probable future sacrifices of economic benefits. 2)Probable future economic benefits owned by the company. 3)Inflows of assets from ongoing, major activities. 4)Decrease in equity from peripheral or incidental transactions.

1)Liabilities 2)Assets 3)Revenues 4)Losses

Identify the accounting concept that was violated in each of the following situations. 4) Don Smith is the sole owner of a company called Hardware City. The company recently paid a $150 utility bill for Smith's personal residence and recorded a $150 expense. 5) Golden Book Company purchased a large printing machine for $1,000,000 (a material amount) and recorded the purchase as an expense. 6) Ace Appliance Company is involved in a major lawsuit involving injuries sustained by some of its employees in the manufacturing plant. The company is being sued for $2,000,000, a material amount, and is not insured. The suit was not disclosed in the most recent financial statements because no settlement had been reached.

4) The economic entity assumption 5) Expense recognition; materiality 6) The full disclosure principle

Answer each of the following questions related to these characteristics and constraints. 5) In general, relevant information possesses which qualities? 6) When there is agreement between a measure or description and the phenomenon it purports to represent, information possesses which characteristic? 7) Jeff Brown is evaluating two companies for future investment potential. Jeff's task is made easier because both companies use the same accounting methods when preparing their financial statements. Which characteristic does the information Jeff will be using possess? 8) A company should disclose information only if the perceived benefits of the disclosure exceed the costs of providing the information. Which constraint does this statement describe?

5) Predictive value and/or confirmatory value 6) Faithful representation 7) Comparability 8) Cost effectiveness

Identify the accounting concept that relates to each statement or phrase below. 6) All economic events can be identified with a particular entity. 7) The benefits of providing accounting information should exceed the cost of doing so. 8) A consequence is that GAAP need not be followed in all situations. 9) Not a qualitative characteristic, but a practical justification for some accounting choices. 10) Assumes the entity will continue indefinitely.

6) Economic entity assumption 7) Cost effectiveness 8) Materiality 9) Conservatism 10) Going concern assumption

Fernblatt Inc. recognizes revenue in the period in which it records an asset for the related account receivable, rather than in the period in which the account receivable is collected in cash. Fernblatt's accounting approach is an example of: Matching. Cash basis accounting. Accrual accounting. Periodicity.

Accrual accounting.

GAAP includes which of the following pronouncements: Statements of Financial Accounting Standards. Accounting Research Bulletins. Accounting Principles Board Opinions. All of the choices are correct.

All of the choices are correct.

Measurement (present or discounted value of future cash flows)

Based on removing the time value of money from future cash flows

measurement (historical cost)

Based on the amount given or received in the original transaction

Measurement (net realizable value)

Based on the amount of cash into which an asset is expected to be converted in the ordinary course of business

Measurement (current cost)

Based on the cost that would be incurred to purchase or reproduce the asset

measurement (fair value)

Based on the price that would be received to sell an asset or paid to transfer a liability at the measurement date- often used for financial assets -Fair Value option: Gives a company the option to choose whether to report financial assets and liabilities at fair value.

Key Constraint: Cost Effectiveness

Benefits of endowing financial information with all the qualitative characteristics must exceed the cost of doing so •Costs include: gathering, processing, and disseminating information; adverse economic consequences of implementing account standards (ex. Lose a competitive advantage by providing the information)

Qualitative Characteristics: Enhancing-

Comparability(including consistency): compare information across companies •Consistency: compare information for one company across reporting periods Verifiability: knowledgeable and independent measurers would reach consensus •ex. Land at historical cost is highly verifiable, land at fair value is less so. Timeliness: information is available for users early enough to allow them to use it in their decision process Understandability: users must comprehend the information within the context of the decision being made •expected that decision maker has a reasonable understanding of business and economic activities

Recognition, Measurement, and Disclosure Concepts: Assumptions-

Economic entity: presumes that economic events can be identified with a particular economic entity Going concern: anticipates that a business entity will continue to operate indefinitely Periodicity: allows the life of a company to be divided into artificial time periods to provide timely information Monetary unit: used in financial statements and is the U.S. dollar(assumes value of the dollar is constant over time).

Qualitative Characteristics: Faithful representation-

Faithful representation is an agreement between a measure or description and the phenomenon it purports to represent. Completeness: includes all information necessary Neutrality: free from bias •Accounting standards should not favor a particular group of companies. Free from error: no errors or omissions in the description of the amount or the process used to report the amount.

Financial statements generally include all of the following except: Income statement. Federal income tax return. Balance sheet. Statement of cash flows.

Federal income tax return.

Who was the first body to set accounting standards in the U.S.? Please select the best answer below. Financial Accounting Standards Board (FASB) Accounting Principles Board (APB) American Institute of Certified Public Accountants (AICPA) Financial Accounting Foundation (FAF)

Financial Accounting Standards Board (FASB)

The type of financial information to external decision makers is referred to as: Public accounting. Government accounting. Financial accounting. Managerial accounting.

Financial accounting.

In general, revenue is recognized when the earnings process is virtually complete and: Goods or services are transferred to the customer. A purchase order is received. Cash is collected. Production is completed.

Goods or services are transferred to the customer.

Qualitative Characteristics: Fundamental Relevance-

Predictive value: helps users predicts future cash flows Confirmatory value: confirms or changes users prior expectations regarding the company's cash-flow generating ability Materiality: omitting or misstating the information affects users decisions •Relative (not a set $ amount) •Nature of item matters - ex. Bribe, amount causes company to meet or beat earnings, etc.

Recognition, Measurement, and Disclosure Concepts: Principles-

Revenue recognition: Recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services. Expense recognition: Often matches revenues and expenses that arise from providing the same goods or services(cause and effect relationship). Mixed-attribute measurement: Mixed attribute model- elements have different bases of measurement. (Historical costs, Net realizable value, Current cost, Present value of future cash flows, Fair value). Full disclosure: Requires that the financial reports should include any information that could affect the decisions made by external users.