Accounting Concepts & Assumptions

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Introduction to Accounting

Accounting Concepts & Assumptions

Key Things To Know

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Practice Test

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Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1.   The historical cost concept requires assets to be reported at

a.  fair market value
b.  appraised value
c.  the amount paid for the asset
d.  future value

Check Your Answer
C.   Assets are recorded at historical cost, the amount paid, because historical cost is the most reliable amount at the time of purchase.  Fair market value and appraised value are not reliable. Assets are not adjusted to future values.
2.  The concept that requires an estimated value of an asset be made at the assets lowest value is called

a.  relevance
b.  conservatism
c.  conceptualism
d.  reliability

Check Your Answer
B.  Conservatism requires assets to be reported at the lowest value when an estimate is made of the amount.  This applies only when an estimate is made.  Relevance means it makes a difference to the user’s decision.  Conceptualism is not a concept. An estimate is not reliable.
3.  The two qualities that make accounting the most useful are

a.  relevance and reliability
b.  entity and conservatism
c.  historical cost and relevance
d.  reliability and verifiability

Check Your Answer
A.   Relevance means that the information is useful to the decision maker and reliability means that the information can be trusted.  Without this financial information is not useful. Verifiability is a subset of reliability. Historical cost is not relevant in most cases, but it is reliable.  Conservatism prevents the user from being misled; however, it is not as critical as relevance and reliability.
4.  The assumption that a company will continue in business, use its assets to produce revenues and pay liabilities is called

a.  conservatism
b.  entity
c.  going concern
d.  reliability

Check Your Answer
C.   The going concern assumption is that the company will continue in business.  As the company continues in business it is assumed that assets will be used to produce revenues and liabilities will be paid.
5.  Which of the following requires that a company maintain separate records that pertain only to the business?

a.  entity
b.  going concern
c.  reliability
d.  consistency

Check Your Answer
A.  The entity assumption requires that only the transactions of the company be recorded and reported in the company’s financial statements.  An owner may never mix their personal transactions with the company’s transactions.
6.  In simple terms, the revenue recognition principle states 

a.  revenues are recognized when expenses occur
b.  revenues are recognized when earned
c.  revenues are recognized when cash is collected
d.  revenues are recognized when the order is placed

Check Your Answer
B.  The revenue recognition principle states that revenues are recognized when the goods or services are provided and you believe you will be paid.  This is “when earned”.

When the cash is collected does not matter.  Expenses are not part of the revenue recognition principle.

7.  The matching principle means which accounts must be matched?

a.  revenues and expenses
b.  assets and liabilities
c.  revenues and assets
d.  expenses and liabilities

Check Your Answer
A.  The matching principle states that revenues and expenses must be matched in the same period.  All expenses incurred to generate the revenue must be reported in the same period as the revenue.
8.  The term relevant refers to

a.  whether or not a liability should be paid
b.  whether or not something will make a difference to the user
c.  whether or not the company made an error
d.  whether or not the company has enough liquid assets to pay liabilities

Check Your Answer
B.  Relevant means that it makes a difference in the decision made by a financial statement user.
9.  Consistency means

a.  the company must always do the same business transactions
b.  the company must use the same accounting policies
c.  the company must recognize revenues when collected
d.  the company must show two years on the balance sheet

Check Your Answer
B.  Consistency means the company must use the same accounting policies from one period to the next.  Consistent accounting policies must be used for similar transactions. Revenues are recognized when earned, not when collected.  (d) refers to comparability.
10.  The objectives of financial reporting are all associated with

a.  helping the company make more money
b.  helping the user of financial statements understand the company’s financial position
c.  making sure transactions get reported timely
d.  making sure the financial statements are 100% accurate

Check Your Answer
B.  The objectives of financial reporting are all associated with providing useful information to the user of the financial statements.  Information on assets, liabilities and cash flows help the user understand the financial position of the company. Transactions must be reported timely, but this is not part of the objectives.  Financial statements are never 100% accurate, however, they should be materially stated in accordance with GAAP. Reporting does not in itself make more money.
11.  The monetary assumptions refers to

a.  all items are reported in dollars
b.  inflation is not accounted for
c.  the dollar will fluctuate greatly over time
d.  financial statements must be conservative

Check Your Answer
B.  The monetary assumptions assumes that the dollar is stable over time and inflation is not accounted for. 
12. Comparability means

a.  the user can compare performance to a company in the same industry
b.  trends within the company are difficult to determine
c.  the company uses the same accounting principles
d.  inflation is not a factor when comparing this year to last year

Check Your Answer
A.  Comparability occurs when the company provides more than one period of information and uses a consistent format and accounting policies.  This allows for comparing one period to the next and one company to another. Comparing one period to another allows for trend analysis. ( c) is consistency.  (d) is the monetary assumption.
13.  Full disclosure is achieved by presenting

a.  two years of financial information
b.  three years of financial information
c.  footnotes
d.  a description of the company’s business

Check Your Answer
C.  Full disclosure means the company provides all information that is material that will impact a user’s decision.  Footnotes provide additional information that is material that is not on the financial statements. Comparability is achieved by providing more than one year of information (a. & b.). 
14.  The term materiality refers to

a.  is net income large enough for the company to be a good investment
b.  whether an amount is small enough to sway the user
c.  whether an amount is big enough to make a difference to the user
d.  how much income changes from one year to another

Check Your Answer
C.  Materiality means — is the amount large enough to make a difference to the user?

The company may report items that are not 100% accurate or not in accordance with GAAP if it is not material and does not matter to the user.  

15.  The cost benefit principle makes sure the company

a.  does not spend too much on day to day expenses
b.  does not spend more gathering accounting data than its value to the user of the financial information
c.  is always making money
d.  discloses all information

Check Your Answer
B.  The cost benefit principle was put in place to make sure the company was not spending more to provide financial information than the financial information is worth to the user.   Companies only disclose material information.
16.  Reliability simply means

a.  the user can trust the financial information is true
b.  a user always relies on the information 
c.  it is not possible for the financial information to be more relevant
d.  the financial information is always conservative

Check Your Answer
A.  Reliability means it is what it says it is and it can be relied upon and the user will not be mislead.  The user can trust that the company is representing the financial results as they truly are and trust and rely on it.