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142 Financial Accounting: A Business Perspective 9e 5 ACCOUNTING THEORY ANSWERS TO QUESTIONS 1. The major underlying assumptions are the (1) business entity, (2) going concern (continuity), (3) money measurement, (4) stable dollar, and (5) periodicity (time periods). The assumption that the dollar is a stable unit of measurement is unrealistic during periods of high inflation. 2. The business entity concept is relied on in determining which transactions are recorded in a certain set of records. For example, which transactions should be recorded in the accounts of Ford as contrasted with which transactions should be recorded in the accounts of General Motors? 3. The going-concern assumption should not be used when there is evidence that the entity will terminate. 4. The accrual basis of accounting means that revenues are recorded when services are rendered or when products are sold and delivered. Expenses are recorded as incurred. The alternative is the cash basis of accounting, which recognizes revenues and most expenses when cash is received or paid. 5. Sometimes the legal form of an agreement may conflict with its economic substance, such as a contract legally drawn as a rental arrangement but whose terms are such that it is in substance an installment purchase. The contract should be reported as a purchase by the accountant. 6. When a change in principle is made, disclosure of the change and its effects on net income, if material, is required. Justification of the change must also be given. 7. The exchange-price principle states that transfers of resources are to be recorded at the time of transfer and at the exchange prices agreed upon. Adherence to this principle generally determines what goes into the accounting system, including the time of entry and the amounts reported for assets, expenses, liabilities, revenues, and stockholders' equity. 8. Generally, revenues must be earned and realized before they are recognized. That is, they must have been brought into existence by the firm's activities and must have been validated, usually by means of an exchange. 9. Recognizing revenue at the time of cash collection is considered acceptable (1) in small service businesses with only nominal amounts of accounts receivable, (2) when cash receipt and time of sale coincide, and (3) under the installment method where collectibility of the installment receivables is in doubt. 10. The two methods that may be used for long-term construction contracts are the completed- contract method and the percentage-of-completion method. The completed-contract method recognizes revenues at the point of sale (when the project is complete). The percentage-of- completion method recognizes revenues based on the estimated stage of completion of the project. 11. An expense is a
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This note was uploaded on 02/08/2011 for the course ACCT 2101 taught by Professor Turner during the Spring '08 term at Georgia Institute of Technology.

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