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Learning Objective 01-02 Explain the difference between cash and accrual accounting.
 
Cash basis accounting provides a measure of periodic performance called net operating cash flow, which is the difference between cash
receipts and cash disbursements from transactions related to providing goods and services to customers. Accrual accounting provides a
measure of performance called net income, which is the difference between revenues and expenses. Periodic net income is considered a
better indicator of future operating cash flows than is current net operating cash flows.
   
Knowledge Check 01
On July 1, Year 1, a company paid $48,000 for 24 months of advance rent on its warehouse. Assuming the company has a December year end,
what would be the amount of rent expense in Year 1 under cash basis versus accrual accounting?
 
Cash basis = $48,000; Accrual = $12,000.
  Learning Objective 01-07 Identify the objective and qualitative characteristics of financial reporting information and the elements of financial statements.
 
The objective of financial reporting is to provide useful financial information to capital providers.
The primary decision-specific qualities that make financial information useful are relevance and faithful representation.
To be relevant, information must possess predictive value and/or confirmatory value, and all material information should be included.
Completeness, neutrality, and freedom from error enhance faithful representation. The 10 elements of financial statements are assets,
liabilities, equity, investments by owners, distributions to owners, revenues, expenses, gains, losses, and comprehensive income.
 
 
The primary focus of financial accounting information is to provide useful information for users to make:
 

Investing Decisions

Credit Decisions

Yes                                           Yes The FASB’s conceptual framework’s qualitative characteristics of accounting include:
Relevance
   
Which of the following qualities is not a requirement of representational faithfulness?
 
neutrality
timeliness
free from error
complete
  Learning Objective 01-08 Describe the four basic assumptions underlying GAAP.
The four basic assumptions underlying GAAP are
(1) the economic entity assumption,
(2) the going concern assumption,
(3) the periodicity assumption, and
(4) the monetary unit assumption.
 
Match the term and the definition.
 
Revenues: Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods,
rendering services, or other activities that constitute the entity's ongoing central operations
 
Expenses: Outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services,
or other activities that constitute the entity's ongoing central operations
 
Assets: Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events
 
Liabilities: Probably 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 of events
 
Equity: Residual interest in the assets of an entity that remains after deducting its liabilities
   
Choose the word pair that fills in the blanks correctly:
A parent company and its subsidiaries are separate ________entities but one _______ entity.
 
legal; accounting
   
Which of the following assumes that in the absence of contrary information a business entity will continue indefinitely?
 
Going concern assumption
  Which of the following assumes the economic life of a company can be divided into time periods for financial reporting?
 
Periodicity assumption
   
Which of the following is a presumption of the monetary unit assumption?
The value of the currency used in measuring transactions is stable over time.
  Learning Objective 01-09
Describe the recognition, measurement, and disclosure concepts that guide accounting practice.
Recognition determines whether an item is reflected in the financial statements, and measurement determines the amount of the item.
Measurement involves choice of a monetary unit and choice of a measurement attribute. In the United States, the monetary unit is the dollar.
Various measurement attributes are used in GAAP, including historical cost, net realizable value, current cost, present value, and fair value.
 
(1) Definitions—The item meets the definition of an element of financial statements.
(2) Measurability—It has a relevant attribute measurable with sufficient reliability.
(3) Relevance—The information is capable of making a difference in user decisions.
(4) Reliability—The information is representationally faithful, verifiable, and neutral.
   
Which of the following methods of measurement is allowed under U.S. GAAP?
a. Current cost
b. Fair value
c. Historical cost
d. All of these methods are allowed.
   
Notes to the company’s financial statements are:
 
An integral part of the company's financial statements.
   
Exercise 1-2 (Algo) Accrual accounting [LO1-2]
Listed below are several transactions that took place during the second and third years of operations for the RPG Company
 
                                                                                                                           Year 2       year 3

Amounts billed to customers for services rendered	$	260,000		$	360,000
Cash collected from credit customers		170,000			310,000
Cash disbursements:
Payment of rent		71,000			0
Salaries paid to employees for services rendered during the year		131,000			151,000
Utilities		21,000			31,000
Advertising		10,500			26,000

 
In addition, you learn that the company incurred advertising costs of $16,000 in year 2, owed the advertising agency $4,100 at the end of year 1, and there were no liabilities at the end of year 3. Also, there were no anticipated bad debts on receivables, and the rent payment was for a two-year period, year 2 and year 3.
 
Required:
1. Calculate accrual net income for both years.
2. Determine the amount due the advertising agency that would be shown as a liability on RPG’s balance sheet at the end of year 2.
 


   
Exercise 1-6 (Static) Financial statement elements [LO1-7]
For each of the items listed below, identify the appropriate financial statement element.
 
 
Exercise 1-7 (Static) Concepts; terminology; conceptual framework [LO1-7]
Listed below are several terms and phrases associated with the FASB’s conceptual framework.
Pair each item from List A with the item from List B that is most appropriately associated with it.

   
Exercise 1-9 (Static) Basic assumptions, principles, and constraints [LO1-7, 1-8, 1-9]
Listed below are several terms and phrases associated with the accounting concepts.
Pair each item from List A with the item from List B that is most appropriately associated with it.
 

   
Exercise 1-10 (Static) Basic assumptions and principles [LO1-7, 1-8, 1-9]
Listed below are several statements that relate to financial accounting and reporting. Identify the accounting concept that applies to each statement.
 

   
Exercise 1-11 (Static) Basic assumptions and principles [LO1-8, 1-9]
Identify the accounting concept that was violated in each of the following situations.

   
TB MC Qu. 1-129 (Algo) The following information ($ in millions) comes from a recent annual...
The following information ($ in millions) comes from a recent annual report of Amazon.com, Inc.:
 

Net sales	$	10,776
Total assets		4,467
End of year balance in cash		1,087
Total stockholders' equity		481
Gross profit (Sales − Cost of Sales)		2,565
Net increase in cash for the year		9
Operating expenses		2,049
Net operating cash flow		795
Other income (expense), net		(30	)

  
Compute the income before income tax for Amazon.

Top of Form

Multiple Choice

 

$486

 

Bottom of Form

Explanation

Net income = Gross profit − Operating expenses + Other income (expense), net
= $2,565 − $2,049 + $(30) = $486

 

 

TB MC Qu. 1-124 (Algo) Tri Fecta, a partnership, had revenues of...

Tri Fecta, a partnership, had revenues of $373,000 in its first year of operations.

The partnership has not collected on $45,200 of its sales and still owes $38,600 on $190,000 of merchandise it purchased.

There was no inventory on hand at the end of the year. The partnership paid $33,500 in salaries.

The partners invested $43,000 in the business and $26,000 was borrowed on a five-year note.

The partnership paid $2,080 in interest that was the amount owed for the year and paid $9,700 for a two-year insurance policy on the first day of business.
 
Compute net income for the first year for Tri Fecta.

Top of Form

Multiple Choice

 

$142,570

 

Explanation

Revenues				$	373,000
Expenses:
Cost of Goods Sold	$	190,000
Salaries expense		33,500
Interest expense		2,080
Insurance expense		4,850			230,430
Net income				$	142,570

 

 

TB MC Qu. 1-127 (Algo) The following information ($ in millions) comes from a recent annual...

The following information ($ in millions) comes from a recent annual report of Amazon.com, Inc.:
 

Net sales	$	10,852
Total assets		4,410
End of year balance in cash		1,100
Total stockholders' equity		455
Gross profit (Sales − Cost of Sales)		2,635
Net increase in cash for the year		29
Operating expenses		2,053
Net operating cash flow		701
Other income (expense), net		(30	)

 

Compute Amazon's total liabilities at the end of the year.

Top of Form

Multiple Choice

 

$3,955

 

Bottom of Form

Explanation

Total assets = Total liabilities + Total Stockholders' equity
Therefore, Total liabilities = Total assets − Total Stockholders' equity
= $4,410 − $455 = $3,955.

 

 

TB MC Qu. 1-61 (Static) The FASB's conceptual framework's qualitative...

The FASB's conceptual framework's qualitative characteristics of accounting information include:

Top of Form

Multiple Choice

 

Relevance.

 

 

TB MC Qu. 1-101 (Static) The full disclosure principle requires a...

The full disclosure principle requires a balance between:

Top of Form

Multiple Choice

 

Relevance and cost-effectiveness.

 

 

TB TF Qu. 1-19 (Static) The FASB's conceptual framework lists...

The FASB's conceptual framework lists relevance and timeliness as the two fundamental qualitative characteristics of decision, useful information.

 

False

 

 

TB MC Qu. 1-89 (Static) Which of the following Statements of...

Which of the following Statements of Financial Accounting Concepts defines the 10 elements of financial statements?

Top of Form

Multiple Choice

 

SFAC 6

 

 

TB TF Qu. 1-20 (Static) The monetary unit assumption requires that...

The monetary unit assumption requires that items in financial statements be measured in a particular monetary unit.

 

True

 

 

TB MC Qu. 1-42 (Static) Which of the following is...

Which of the following is not a provision of the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes-Oxley)?

The Act:

 

Changed the entity responsible for setting accounting standards.

 

 

TB TF Qu. 1-26 (Static) In IFRS, the conceptual framework indicates appropriate...

In IFRS, the conceptual framework indicates appropriate accounting when a more specific accounting standard does not apply.

 

True

 

 

Brief Exercise 1-5 (Static) Basic assumptions and principles [LO1-7, 1-8, 1-9]

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.

 

 

 

Exercise 1-1 (Algo) Accrual accounting [LO1-2]

Listed below are several transactions that took place during the first two years of operations for the law firm of Pete, Pete, and Roy.
 

	Year 1			Year 2
Amounts billed to clients for services rendered	$	184,000		$	234,000
Cash collected from clients		167,000			197,000
Cash disbursements
Salaries paid to employees for services rendered during the year		97,000			107,000
Utilities		33,500			47,000
Purchase of insurance policy		62,100			0

 
In addition, you learn that the firm incurred utility costs of $38,500 in year 1, that there were no liabilities at the end of year 2,

no anticipated bad debts on receivables, and that the insurance policy covers a three-year period.
 
Required:

1. & 3. Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the

firm would show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.
2. Prepare an income statement for each year according to the accrual accounting model.

 

Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the firm would show in its

year 1 and year 2 balance sheets prepared according to the accrual accounting model.

(Net cash outflows should be indicated by a minus sign.)

 

 

Prepare an income statement for each year according to the accrual accounting model.

 

  

Explanation

1. & 3.

Pete, Pete, and Roy
Operating Cash Flow
	Year 1			Year 2
Cash collected	$	167,000		$	197,000
Cash disbursements:
Salaries		(97,000	)		(107,000	)
Utilities		(33,500	)		(47,000	)
Purchase of insurance policy		(62,100	)		0
Net operating cash flow	$	(25,600	)	$	43,000

 

Year 1:	Amount billed to clients	$	184,000
	Less: Cash collected		(167,000	)
	Ending accounts receivable	$	17,000
Year 2:	Beginning accounts receivable	$	17,000
	Plus: Amounts billed to clients		234,000
		$	251,000
	Less: Cash collected		(197,000	)
	Ending accounts receivable	$	54,000

 

 

 

TB MC Qu. 1-124 (Algo) Tri Fecta, a partnership, had revenues of...

Tri Fecta, a partnership, had revenues of $375,000 in its first year of operations.

The partnership has not collected on $45,800 of its sales and still owes $38,000 on $150,000 of merchandise it purchased.

There was no inventory on hand at the end of the year. The partnership paid $28,300 in salaries.

The partners invested $47,000 in the business and $24,000 was borrowed on a five-year note.

The partnership paid $2,160 in interest that was the amount owed for the year and paid $9,800 for a two-year insurance policy on the first day of business.

Compute net income for the first year for Tri Fecta.

 

Top of Form

 

$189,640

 

Bottom of Form

Explanation

Revenues				$	375,000
Expenses:
Cost of Goods Sold	$	150,000
Salaries expense		28,300
Interest expense		2,160
Insurance expense		4,900			185,360
Net income				$	189,640

 

 

TB MC Qu. 1-128 (Algo) The following information ($ in millions) comes from a recent annual...

The following information ($ in millions) comes from a recent annual report of Amazon.com, Inc.:
 

Net sales	$	10,826
Total assets		4,464
End of year balance in cash		1,195
Total stockholders' equity		503
Gross profit (Sales − Cost of Sales)		2,637
Net increase in cash for the year		27
Operating expenses		2,067
Net operating cash flow		731
Other income (expense), net		(21	)

 

Compute Amazon's cost of goods sold for the year.

Top of Form

Multiple Choice

 

$8,189

 

Bottom of Form

Explanation

Gross profit = Net sales − Cost of goods sold
Therefore, Cost of goods sold = Net sales − Gross profit
= $10,826 − $2,637 = $8,189

 

 

TB MC Qu. 1-123

Alpaca Corporation had revenues of $310,000 in its first year of operations.

The company has not collected on $20,100 of its sales and still owes $28,200 on $97,000 of merchandise it purchased.

The company had no inventory on hand at the end of the year. The company paid $13,900 in salaries.

Owners invested $20,000 in the business and $20,000 was borrowed on a five-year note.

The company paid $4,800 in interest that was the amount owed for the year, and paid $8,800 for a two-year insurance policy on the first day of business.

Alpaca has an effective income tax rate of 40%. (Assume taxes are paid in the same year).
 
Compute the cash balance at the end of the first year for Alpaca Corporation.

Top of Form

 

$157,640

 

Explanation

Cash receipts:
Sales revenue	$	310,000
Less: Accounts receivable		20,100		$	289,900
Owners' investments					20,000
Note payable					20,000
Total receipts					329,900
Cash disbursements:
Purchases		97,000
Less: Accounts payable		28,200		$	68,800
Salaries paid					13,900
Interest paid					4,800
Insurance paid					8,800
Estimated taxes paid					75,960
Total cash disbursements					172,260
Ending cash balance				$	157,640

Estimated taxes paid = $310,000 less
Cost of goods sold of $97,000 less $13,900 in salaries less $4,800 interest less $4,400 for insurance ($8,800/2)
equals $189,900. Taxes at 40% are $75,960. 

 

 

TB MC Qu. 1-58 (Static) One of the elements that many...

One of the elements that many believe distinguishes a profession from other occupations is the acceptance of responsibility

by its members for the interests of those it serves, which is often articulated in:

Top of Form

 

Its code of ethics.Bottom of Form

 

 

TB TF Qu. 1-3 (Static) The FASB is currently the public-sector organization...

The FASB is currently the public-sector organization responsible for setting accounting standards in the United States.

 

False

 

 

TB MC Qu. 1-99 (Static) Disclosure notes to a company's financial...

Disclosure notes to a company's financial statements:

Top of Form

Multiple Choice

 

Are an integral part of a company's financial statements.

 

 

TB MC Qu. 1-33 (Static) Which of the following was the first...

Which of the following was the first private-sector entity that set accounting standards in the United States?

Top of Form

Multiple Choice

 

Committee on Accounting Procedure.Bottom of Form

 

 

TB MC Qu. 1-85 (Static) According to the conceptual framework, verif...

According to the conceptual framework, verifiability implies:

Top of Form

Multiple Choice

 

Consensus.

TB MC Qu. 1-51 (Static) Regarding convergence of accounting...

Top of Form

Regarding convergence of accounting standards, the FASB and IASB: 

Are not likely to achieve full convergence of accounting standards in the near future.

TB MC Qu. 1-110 (Static) The asset/liability approach emphasizes:

The asset/liability approach emphasizes:

Whether amounts on the balance sheet meet the definitions of assets and liabilities.Bottom of Form

 

Brief Exercise 1-1 (Algo) Accrual accounting [LO1-2]

Cash flows during the first year of operations for the Harman-Kardon Consulting Company were as follows:

Cash collected from customers, $360,000;

Cash paid for rent, $44,000;

Cash paid to employees for services rendered during the year, $124,000;

Cash paid for utilities, $54,000.

In addition, you determine that customers owed the company $64,000 at the end of the year and no bad debts were anticipated.

Also, the company owed the gas and electric company $2,400 at year-end, and the rent payment was for a two-year period.
 
Calculate accrual net income for the year.
  

 

Explanation

Revenues ($360,000 + $64,000)	$	424,000
Expenses:
Rent ($44,000 ÷ 2)		(22,000	)
Salaries		(124,000	)
Utilities ($54,000 + $2,400)		(56,400	)
Net income	$	221,600

 

 

Exercise 1-1 (Algo) Accrual accounting [LO1-2]

Listed below are several transactions that took place during the first two years of operations for the law firm of Pete, Pete, and Roy.
 

	Year 1			Year 2
Amounts billed to clients for services rendered	$	182,000		$	232,000
Cash collected from clients		166,000			196,000
Cash disbursements
Salaries paid to employees for services rendered during the year		96,000			106,000
Utilities		33,000			46,000
Purchase of insurance policy		61,800			0

 
In addition, you learn that the firm incurred utility costs of $38,000 in year 1, that there were no liabilities at the end of year 2,

no anticipated bad debts on receivables, and that the insurance policy covers a three-year period.
 
Required:
1. & 3. Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the firm
              would show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.
2. Prepare an income statement for each year according to the accrual accounting model.

 

Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the firm would
show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.
(Net cash outflows should be indicated by a minus sign.)

Prepare an income statement for each year according to the accrual accounting model.

  

Explanation

1. & 3.

Pete, Pete, and Roy
Operating Cash Flow
	Year 1			Year 2
Cash collected	$	166,000		$	196,000
Cash disbursements:
Salaries		(96,000	)		(106,000	)
Utilities		(33,000	)		(46,000	)
Purchase of insurance policy		(61,800	)		0
Net operating cash flow	$	(24,800	)	$	44,000

 

Year 1:	Amount billed to clients	$	182,000
	Less: Cash collected		(166,000	)
	Ending accounts receivable	$	16,000
Year 2:	Beginning accounts receivable	$	16,000
	Plus: Amounts billed to clients		232,000
		$	248,000
	Less: Cash collected		(196,000	)
	Ending accounts receivable	$	52,000