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