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Questions and Answers
What does GAAP primarily provide for financial statements?
Which principle states that an accounting entity will operate indefinitely?
How are nonrelated business interests accounted for in an accounting entity?
Which of the following accurately describes a fiscal year?
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Which principle indicates that money is the basic unit of measurement in financial reporting?
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What does the Time Period Principle facilitate?
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What happens to reported assets if a firm is about to liquidate?
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In a proprietorship, who is legally liable for both personal and business obligations?
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What determines whether an item is considered material in financial statements?
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Under the Full Disclosure Principle, which of the following must be included in financial statements?
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What does the monetary principle assume about money?
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When is revenue recognized according to the Realization Principle?
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What is the main concept of the Historical Cost Principle?
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What are the two phases of the Matching Principle in expense measurement?
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What is the purpose of an Independent CPA Opinion?
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What does the Objectivity Principle require from accountants?
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How does the Consistency Principle affect accounting methods?
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Why might a purchase of a spatula be recorded as an expense and not an asset?
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What is included in the first paragraph of an Independent CPA Opinion?
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What is the aim of the Conservatism Principle in accounting?
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Which of the following is NOT a part of the Matching Principle?
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Which of the following instances would VALIDATE the Objectivity Principle?
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What limitation does the monetary principle have according to its assumptions?
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What is a potential consequence of the Consistency Principle?
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Study Notes
GAAP
- Generally Accepted Accounting Principles (GAAP) are guidelines determined by the Financial Accounting Standards Board (FASB) and its predecessor, the Accounting Principles Board (APB).
- GAAP provides a framework for determining information included in financial statements and how it is prepared and presented.
Accounting Entity Principle
- An accounting entity consists of specific economic purposes including people, assets, liabilities, and activities.
- Accounting information is developed for clearly identified accounting entities such as sole proprietorships, partnerships, and corporations.
- Nonrelated business interests are accounted for separately.
- In corporations, the accounting entity coincides with the legal entity.
- In proprietorships, the accounting entity is separate from the proprietor, who is the legal entity liable for both personal and business obligations.
Going Concern Principle
- Assumes an accounting entity will continue to operate indefinitely.
- Allows for deferring costs to be charged against future revenues.
- Examples include undepreciated assets, ending inventories, and prepaid expenses.
- If a firm is liquidating, the going concern principle is ignored, and assets are reported at current liquidating value, and liabilities at the amount needed to settle debts immediately.
Time Period Principle
- Financial statements are prepared for specific periods, usually one year.
- This assists with decision making and tax purposes.
- The fiscal year is the year chosen for financial measurement, and it may not correspond to the calendar year.
- Fiscal years correspond to the natural business activity cycle.
- Financial reports may use shorter time periods such as one month, months, and year-to-date.
Monetary Principle
- States that money is the basic unit of measurement for financial reporting.
- Provides a common denominator for adding and subtracting heterogeneous transactions over time.
- Allows for comparison of financial statements between and within firms.
- Assumes that money is a stable unit of value over time, which is unrealistic because money loses value.
- Not all value to an organization can be measured in monetary terms.
Historical Cost Principle
- Values assets at the original cost of acquisition.
- Adjustments for price level changes should be considered using price level indices (e.g. prescription price indices).
Objectivity Principle
- Requires unbiased and verifiable measurements.
- Accountants seek the most objective evidence available to support financial statements, such as invoices, cancelled checks, bank statements, inventory counts, deeds, and contracts.
- It's impossible to prevent bias due to alternative accounting methods and future uncertainties.
Consistency Principle
- Requires consistent accounting techniques from period to period.
- Enables comparing financial statements over time.
- Management may change accounting methods if needed for statement users, such as changing depreciation methods.
Conservatism Principle
- Requires selecting accounting methods that neither overstate nor understate facts.
- Accounting takes place in an environment of uncertainty, so doubts should be resolved using options that produce lower net income and less favorable financial positions.
- Use of historical cost exemplifies conservatism.
Materiality Principle
- Refers to the relative importance of an item.
- An item is material if it significantly affects financial statements, influencing user decisions.
- Insignificant transactions are recorded in the most expedient way to save costs.
- Materiality depends on both the amount and nature of the item.
Full Disclosure Principle
- Requires all relevant facts concerning the financial position of a business to be presented in financial statements.
- This includes significant events occurring after the fiscal period but before the release of financial statements.
- Full disclosure can be in the body of a financial statement or in its footnotes.
Realization Principle
- Fundamental to the accrual basis of accounting.
- Revenue is recognized when it is realized, meaning the earning process is complete, and there is objective evidence of the amount earned.
- Revenue is recognized at the time goods are sold or services rendered.
Matching Principle
- Measures expense in two phases.
- The first phase is measuring the cost of goods and services consumed or expired in generating revenue.
- The second phase is matching cost and revenue, determining when acquired goods and services have contributed to revenue.
- At this point, the cost becomes an expense.
Independent CPA Opinion
- An audit opinion is issued by independent certified public accountants after auditing a business's financial statements and accounting records.
- The opinion is published in the company's annual report.
- Standard wording consists of two paragraphs.
- The first paragraph describes the scope of the examination.
- The second paragraph presents the actual opinion.
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Description
This quiz covers the Generally Accepted Accounting Principles (GAAP), focusing on key concepts such as the Accounting Entity Principle and the Going Concern Principle. Test your understanding of the framework guiding financial statement preparation and presentation. Perfect for accounting students and professionals.
