Professional Documents
Culture Documents
1
over a specific period of time. Financial statements are related to the accounting system by their summarizing
large numbers of transactions and account balances, which are themselves described and maintained by the
accounting system.
5. Explain briefly why each of the following groups is interested in the financial statements of a business: (a)
creditors; (b) potential investors; (c) labor unions.
(a) Creditors base decisions on types and amounts of credit to extend based on risk of default. Financial
statements convey the vinancial health of an entity, which determines the future ability of a business to
repay debts.
(b) Potential investors need to evaluate the worthiness of a business as an investment. This requires knowing
whether sales and profits are trending up or down, as well as knowing the amounts and ratios of various
asset accounts to liability accounts. This information is conveyed in financial statements.
(c) Labor unions are interested in increasing their members compensation and job security. As both are
related to profitability and revenue, especially to trends in these results, labor unions are interested in
financial statements for their conveying information about these results.
6. The following questions relate to the term “generally accepted accounting principles”:
(a) What type of accounting reports should be prepared in conformity with these principles?:
Among the types of accounting reports prepared are: financial statements, tax returns, managerial
data, reports to regulatory agencies, and other special-purpose reports that may be requested by lenders or
investors. Only financial statements—the end-result of financial accounting—need be prepared in accordance
with GAAP. Although tax returns and reulatory filings are generally prepared under guidelines broadly
similar to GAAP, the princples under which they are prepared are determined by the authorities that
require them and they should be prepared in accordance with these principles. Reports to specific users,
such as lenders and managers, are part of managerial accounting and should be prepared to be most useful
to these users, not necessarily according to GAAP.
(b) Why is it important for these principles to be widely recognized?:
Generally accepted accounting principles need to be widely recognized so that they are widely applied.
Wide application creates conformity in financial accounting across companies and across accountants. This
conformity in preparing accounting information allows financial statements prepared by different accountants
and regarding different entities to be broadly comparable.
(c) Where do these principles come from?
Some GAAP principles are specific prnouncements of the FASB. Others have arisen as professional
conventions from their widespread use and adaption. Of note, GAAP principles are formalized in the private
sector, not as promulgated government regulation.
(d) List two examples of generally accepted acounting principles that relate to the valuation of assets:
The cost principle requires that assets be valued at an objective, definite monetary amount; generally,
this is taken as meaning the historical purchase price, not assessed or current value. Using assessed value
rather than historical cost would involve estimation and thus would violate the cost principle.
The going-concern assumption prevents assets from being valued at replacement cost in times of high
inflation. The going-concern principle states that assets are purchased to be used in the business’ operations,
not for investment purposes. Hence, their value as an asset only derives from profitable operations, not from
gains in intrinsic value.
2
8. What is the principle function of certified public accountants? What other services are commonly rendered
by CPA firms?
The principle function of CPAs is auditing. Other servies commonly rendered by CPA firms are income-
tax services, management advisory services, and small business servies.
9. Private accounting includes a number of subfields or specialized phases, of which cost accounting is one.
Name four other specialized phases of private accounting:
Besides cost accounting, other specialized phases of private accounting are: design of accounting systems,
financial forecasting, internal auditing, and management accounting.
10. Is the FASB a government agency? What is its principle function?
The FASB is a private-sector organization. It is a non-profit organization, supported by the accounting
profession, that conducts research into accounting problems. It also issues Statements of Financial Acounting
Standards, which represent statements of GAAP. (Besides these statements, many things comprise GAAP,
including long-standing and widespread professional conventions.)
11. One primary objective of every business is to operate profitably. What other primary objective must be
met for a business to survive? Explain.
Profitability is the conditon of a company’s revenue exceeding its expenses, so its net income is positive.
Revenue is composed of cash as well as non-cash items. Thus, a companycould be profitable but see its cash
assets decline in that period. Without cash, a business cannot pay its debts as they fall due, no matter how
great its non-cash assets are. This condition of having sufficient cash on hand to pay debts as they fall due
is known as solvency. Profitability and solvency are the two primary objectives of every business.
12. Not all the significant happenings in the life of a business can be expressed in monetary terms and
entered in the accounting records. Identify two or more significant events affecting a business that could not
be satifactorily measured and entered in its accounting records.
The death of a key executive, the openig of a competitor adjacent or across the street from a retail
business, and the development of a disruptive technology that renders a business’ equipment or processes
obsolete are all such examples. These three events share the characteristics of being forward-reaching in their
effects; contingent on factors that cannot be precisely measured, partly due to their future and conditional
nature; and, that their financial effect on a business cannot be described in terms a business transaction
with objectively-determined, monetarily-precise amounts. Rather, they all presage possible future outcomes
that may or may not occur and which, if negative, may likely be seen in effect as slowly-declining revenue
and net income over years or decades. Or, the outcomes may be positive; or, the effects rapid.
13. Information available from the accounting records provides a basis for making many business decisions.
List five examples of business decisions requiring the use of accounting information:
i) Whether a change in operating processes resulted in increased net income;
ii) Whether sales increased after a new marketing campaign;
iii) Whether all locations contribute equally to profitability;
iv) Whether a purchase is better made by cash or by debt;
v) Whether delinquent accounts are increasing.
14. What are the objectives of a company’s system of internal control?
The primary objective of a system of internal control is to assure a company’s management that the
accounting information it receives is accurate and reliable. The constituent objectives are that the organiza-
tion protects its resources against waste, fraud, and inefficiency; that the accounting and operating data is
accurate and reliable; that company policies are complied with; and that the level of performance is properly
evaluated across all levels and divisions of the company. In sum, the system of internal control is intended
to assure that the entire business operates according to plan.
15. Define assets; list 5 examples:
Assets are economic resources that are owned by the business and which are expected to benefit future
operations and production. Cash, land, buildings, equpment, supplies, and accounts receivable are all assets.
3
16. Define liabilities; list 5 examples:
Liabilities are debts owed by the business. Accounts Payable, Unearned Revenue, Notes Payable, Salaries
Payable, and Accrued Interest Payable are all liabilities.
17. Ray Company was offered £300,000 cash for the land and buildings occupired by the business. These
assets had been acquired five years ago for a price of £200,000. Ray Company refused the offer, but is
inclined to increase the land and buildings to a total valuation of £300,000 in the balance sheet in order to
show more accurately “how much the building is worth”. Do you agree? Explain.
Assets are properly carried on ledger accounts and, hence, financial statements, at historical cost, also
called “book value”. This is known as the “cost principle”, a generally-accepted accounting principle. The
rationale for the cost principle is that assets are purchased for use in given business considered as a going-
concer; this rationale is also known as the “going-concern assumption”. Now, the measure of “what a business
is worth” is the residual value of assets net of liabilities, which difference is called “Owner’s Equity”.
The worth of a business, from an accounting viewpoint, is its ability to generate net income. In the
case of Ray Company, the land and building are owned for the purpose of utilization in the business line of
operations and this value is already reflected in Owner’s Equity. Assuming that Ray Company is not in the
business of holding real property for appreciation, the greater value reflected by the offer is immaterial to
“what the business is worth,” as it fails the objectivity principle and is not based on an actual transaction.
It does, however, reflect a non-GAAP estimate of the business’ possible liquidation value.
18. Explain briefly the concept of the business entity:
A business entity is a discrete, clearly-delineated organization that can be regarded as a single thing,
a discrete object. Examples are a single proprietorship, partnership, or corporation. Something that is not
a business entity would be an amalgam of volunteers, without a legal charter, even if they jointly paid for
equipment and keep a “kitty”.
19. State the accounting equation in two alternate forms:
i) Assets = Liabilites + Owner0 s Equity
ii) Owner0 s Equity = Assets − Liabilities
20. The owner’s equity in a business arises from what two sources?
Investments of capital and net income from profitable operation.