1、Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-1Chapter 1 Environment and Theoretical Structure of Financial AccountingQUESTIONS FOR REVIEW OF KEY TOPICSQuestion 1-1Financial accounting is concerned with providing relevant financial information about various kinds of org
2、anizations to different types of external users. The primary focus of financial accounting is on the financial information provided by profit-oriented companies to their present and potential investors and creditors.Question 1-2Resources are efficiently allocated if they are given to enterprises tha
3、t will use them to provide goods and services desired by society and not to enterprises that will waste them. The capital markets are the mechanism that fosters this efficient allocation of resources.Question 1-3Two extremely important variables that must be considered in any investment decision are
4、 the expected rate of return and the uncertainty or risk of that expected return.Question 1-4In the long run, a company will be able to provide investors and creditors with a rate of return only if it can generate a profit. That is, it must be able to use the resources provided to it to generate cas
5、h receipts from selling a product or service that exceeds the cash disbursements necessary to provide that product or service.Question 1-5The primary objective of financial accounting is to provide investors and creditors with information that will help them make investment and credit decisions.Ques
6、tion 1-6Net operating cash flows are the difference between cash receipts and cash disbursements during a period of time from transactions related to providing goods and services to customers. Net operating cash flows may not be a good indicator of future cash flows because, by ignoring uncompleted
7、transactions, they may not match the accomplishments and sacrifices of the period.Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-2Answers to Questions (continued)Question 1-7GAAP (generally accepted accounting principles) are a dynamic set of both broad and specific guid
8、elines that a company should follow in measuring and reporting the information in their financial statements and related notes. It is important that all companies follow GAAP so that investors can compare financial information across companies to make their resource allocation decisions.Question 1-8
9、In 1934, Congress created the SEC and gave it the job of setting accounting and reporting standards for companies whose securities are publicly traded. The SEC has retained the power, but has delegated the task to private sector bodies. The current private sector body responsible for setting account
10、ing standards is the FASB.Question 1-9Auditors are independent, professional accountants who examine financial statements to express an opinion. The opinion reflects the auditors assessment of the statements fairness, which is determined by the extent to which they are prepared in compliance with GA
11、AP. The auditor adds credibility to the financial statements, which increases the confidence of capital market participants relying on that information.Question 1-10On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. The most dramatic change to federal securities laws si
12、nce the 1930s, the Act radically redesigns federal regulation of public company corporate governance and reporting obligations. It also significantly tightens accountability standards for directors and officers, auditors, securities analysts and legal counsel. Student opinions as to the relative imp
13、ortance of the key provisions of the act will vary. Key provisions in the order of presentation in the text are: Creation of an Oversight Board Corporate executive accountability Non-audit services Retention of work papers Auditor rotation Conflicts of interest Hiring of auditor Internal controlChap
14、ter 01 - Environment and Theoretical Structure of Financial Accounting1-3Answers to Questions (continued)Question 1-11New accounting standards, or changes in standards, can have significant differential effects on companies, investors and creditors, and other interest groups by causing redistributio
15、n of wealth. There also is the possibility that standards could harm the economy as a whole by causing companies to change their behavior.Question 1-12The FASB undertakes a series of elaborate information gathering steps before issuing an accounting standards update to determine consensus as to the
16、preferred method of accounting, as well as to anticipate adverse economic consequences.Question 1-13The purpose of the conceptual framework is to guide the Board in developing accounting standards by providing an underlying foundation and basic reasoning on which to consider merits of alternatives.
17、The framework does not prescribe GAAP.Question 1-14Relevance and faithful representation are the primary qualitative characteristics that make information decision-useful. Relevant information will possess predictive and/or confirmatory value. Faithful representation is the extent to which there is
18、agreement between a measure or description and the phenomenon it purports to represent. Question 1-15The components of relevant information are predictive and/or confirmatory value. The components of faithful representation are completeness, neutrality, and free from material error.Question 1-16The
19、benefit from providing accounting information is increased decision usefulness. If the information is relevant and possesses faithful representation, it will improve the decisions made by investors and creditors. However, there are costs to providing information that include costs to gather, process
20、, and disseminate that information. There also are costs to users in interpreting the information as well as possible adverse economic consequences that could result from disclosing information. Information should not be provided unless the benefits exceed the costs.Chapter 01 - Environment and Theo
21、retical Structure of Financial Accounting1-4Answers to Questions (continued)Question 1-17Information is material if it is deemed to have an effect on a decision made by a user. The threshold for materiality will depend principally on the relative dollar amount of the transaction being considered. On
22、e consequence of materiality is that GAAP need not be followed in measuring and reporting a transaction if that transaction is not material. The threshold for materiality has been left to subjective judgment.Question 1-181. Assets are probable future economic benefits obtained or controlled by a par
23、ticular entity as a result of past transactions or events.2. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions.3. Equity is th
24、e residual interest in the assets of any entity that remains after deducting its liabilities.4. Investments by owners are increases in equity resulting from transfers of resources, usually cash, to a company in exchange for ownership interest.5. Distributions to owners are decreases in equity result
25、ing from transfers to owners. 6. Revenues are inflows of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major or central operations.7. Expenses are outflows or other using up of assets or incurrence
26、s of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major or central operations.8. Gains are defined as increases in equity from peripheral or incidental transactions of an entity.9. Losses represent decreas
27、es in equity arising from peripheral or incidental transactions of an entity.10. Comprehensive income is defined as the change in equity of an entity during a period from nonowner transactions.Question 1-19The four basic assumptions underlying GAAP are (1) the economic entity assumption, (2) the goi
28、ng concern assumption, (3) the periodicity assumption, and (4) the monetary unit assumption.Question 1-20The going concern assumption means that, in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely. This assumption is importan
29、t to many broad and specific accounting principles such as the historical cost principle.Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-5Answers to Questions (continued)Question 1-21The periodicity assumption relates to needs of external users to receive timely financial
30、 information. This assumption requires that the economic life of a company be divided into artificial periods for financial reporting. Companies usually report to external users at least once a year.Question 1-22The four key broad accounting principles that guide accounting practice are (1) the hist
31、orical cost or original transaction value principle, (2) the realization or revenue recognition principle, (3) the matching principle, and (4) the full disclosure principle.Question 1-23Two important reasons to base valuation on historical cost are (1) historical cost provides important cash flow in
32、formation since it represents the cash or cash equivalent paid for an asset or received in exchange for the assumption of a liability, and (2) historical cost valuation is the result of an exchange transaction between two independent parties and the agreed upon exchange value is, therefore, objectiv
33、e and possesses a high degree of verifiability.Question 1-24The realization principle requires that two criteria be satisfied before revenue can be recognized:1. The earnings process is judged to be complete or virtually complete, and,2. There is reasonable certainty as to the collectibility of the
34、asset to be received (usually cash).Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-6Answers to Questions (concluded)Question 1-25The four different approaches to implementing the matching principle are:1. Recognizing an expense based on an exact cause-and-effect relation
35、ship between a revenue and expense event. Cost of goods sold is an example of an expense recognized by this approach.2. Recognizing an expense by identifying the expense with the revenues recognized in a specific time period. Office salaries is an example of an expense recognized by this approach.3.
36、 Recognizing an expense by a systematic and rational allocation to specific time periods. Depreciation is an example of an expense recognized by this approach.4. Recognizing expenses in the period incurred, without regard to related revenues. Advertising is an example of an expense recognized by thi
37、s approach.Question 1-26In addition to the financial statement elements arrayed in the basic financial statements, information is disclosed by means of parenthetical or modifying comments, notes, and supplemental financial statements.Question 1-27GAAP prioritizes the inputs companies should use when
38、 determining fair value. The highest and most desirable inputs, Level 1, are quoted market prices in active markets for identical assets or liabilities. Level 2 inputs are other than quoted prices that are observable including quoted prices for similar assets or liabilities in active or inactive mar
39、kets and inputs that are derived principally from observable related market data. Level 3 inputs, the least desirable, are inputs that reflect the entitys own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information ava
40、ilable in the circumstances.Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-7BRIEF EXERCISESBrief Exercise 1-1Revenues ($340,000 + 60,000) $400,000Expenses:Rent ($40,000 2) (20,000)Salaries (120,000)Utilities ($50,000 + 2,000) (52,000)Net income $208,000Brief Exercise 1-2
41、(1) Liabilities(2) Assets(3) Revenues(4) LossesBrief Exercise 1-31. The periodicity assumption2. The economic entity assumption3. The realization (revenue recognition) principle4. The matching principleBrief Exercise 1-41. The matching principle2. The historical cost (original transaction value) pri
42、nciple3. The economic entity assumptionBrief Exercise 1-51. Disagree The full disclosure principle2. Agree The periodicity assumption3. Disagree The matching principle4. Agree The realization (revenue recognition) principleChapter 01 - Environment and Theoretical Structure of Financial Accounting1-8
43、EXERCISESExercise 1-1Requirement 1Pete, Pete, and RoyOperating Cash FlowYear 1 Year 2Cash collected $160,000 $190,000Cash disbursements:Salaries (90,000) (100,000)Utilities (30,000) (40,000)Purchase of insurance policy (60,000) - 0 - Net operating cash flow $(20,000) $ 50,000Requirement 2Pete, Pete,
44、 and RoyIncome StatementsYear 1 Year 2Revenues $170,000 $220,000Expenses:Salaries (90,000) (100,000)Utilities (35,000) (35,000)Insurance (20,000) (20,000)Net Income $ 25,000 $ 65,000Requirement 3Year 1: Amount billed to customers $170,000Less: Cash collected (160,000)Ending accounts receivable $ 10,
45、000Year 2: Beginning accounts receivable $ 10,000Plus: Amounts billed to customers 220,000$230,000Less: Cash collected (190,000)Ending accounts receivable $ 40,000Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-9Exercise 1-2Requirement 1Year 2 Year 3Revenues $350,000 $450
46、,000Expenses:Rent ($80,000 2) (40,000) (40,000)Salaries (140,000) (160,000)Travel and entertainment (30,000) (40,000)Advertising (25,000) (20,000)*Net Income $115,000 $190,000Requirement 2Amount owed at the end of year one $ 5,000Advertising costs incurred in year two 25,00030,000Amount paid in year
47、 two (15,000)Liability at the end of year two 15,000Less cash paid in year three (35,000)Advertising expense in year three $20,000*Chapter 01 - Environment and Theoretical Structure of Financial Accounting1-10Exercise 1-3Requirement 1FASB ASC 820: “Fair Value Measurements and Disclosures”Requirement
48、 2The specific citation that describes the information that companies must disclose about the use of fair value to measure assets and liabilities for recurring measurements is FASB ASC 82010502: “Fair Value Measurements and Disclosures-Overall-Disclosures.”Requirement 3The disclosure requirements are:a. The fair value measurements at the reporting date
