Chapter 1
1. What is an asset? Give three examples.
Any item of economic
value owned by an individual
or corporation, especially
that which could be converted to cash.
Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car, and other property. On a balance
sheet, assets are equal to the sum of liabilities, common stock, preferred
stock, and retained earnings. From an accounting perspective, assets are divided into the following
categories: current assets (cash and other liquid items), long-term
assets (real estate, plant, equipment), prepaid and deferred
assets (expenditures for future costs such as insurance, rent, interest),
and intangible assets (trademarks, patents, copyrights, goodwill).
2. What is liability? How does the definition of
liability relate to the definition of asset?
A liability is an obligation of a business; it can
take many different forms. When a company borrows money at a bank, the
liability is called a note payable. When a company sells bonds, the obligation
is termed bonds payable. Amounts owed to the government for taxes are called
tax payable.
In other word it can be defined as the claims over
the assets of the firm by its creditors. They are the obligations to transfer
assets or to provide services resulting from past transactions. The liabilities
should be in the form of accounts payable, notes payable, tax payable, bills
payable, interest payable, and unearned revenues.
3. Business entities are organized as one of three
distinct forms. What are these three forms?
Business entities are organized to earn a profit.
Legally, a profit-oriented company is one of three types: a sole
proprietorship, a partnership, or a corporation.
a.
Sole Proprietorship:
This form of
organization is characterized by a single owner. Many small businesses are
organized as sole proprietorships. The business is owned and operated by the
same person. The accounting job is much simplified by the separate entity
concept, which views the business as having an existence separate from its
owners. In conformity to this principle, the business resources and the
activities of the owner must be segregated from the proprietor’s other
resources and activities.
b.
Partnerships:
A partnership is a
business owned by two or more individuals. Many small businesses begin as
partnerships. When two or more partners start out, they need some sort of
agreement as to how much each will contribute to the business and how they will
divide any profits. In large businesses, the partnership agreement is
formalized in a written document known as partnership deed. Like sole proprietorship,
a partnership is not a taxable entity. Individual partners pay taxes on their
proportionate share of business profits.
c.
Corporations:
A corporation is the
corporate body formed to carry out a particular purpose in common by persons
and individuals that have contributed to its capital. The capital is divided
into various units, known as share making it easy for number of persons to
participate in the ownership of a company. Company is considered an artificial
person invisible, intangible and existing only in the eyes of the law. It can
maintain, buy or sell both movable and immovable properties incur and pay debts
open a bank account in its own name and petition the court and be prosecuted in
the same manner as an individual. To start a corporation, one must file
articles of incorporation with the state or country.
4. What are the three distinct types of business
activity in which companies engage? Assume that you start your own company to
rent bicycles in the summer and skis in the winter. Give an example of at least
one of each of the three types of business activities in which you would
engage.
Businesses engage in three types of activities:
financing, investing and operating. Financing is necessary to start a business,
and funds are obtained from both stockholders and creditors. These funds are
invested in the various assets needed to run a business. Once funds are
obtained and investments made in productive assets, a business begins operations,
which may consist of providing goods or services or both.
a.
Operating Activities:
The transactions that
effect the determination of net income of the firm are classified as operating
activities. Operating activities are related to acquiring and selling products
and services reported on cash basis. The operating activities show the cash
effects of revenue and expense transactions, which are normally the part of the
income statement. In case of the company to rent bicycles in the summer and
skis in the winter, operating activities involved are cash received as rent,
payment made to supplies and payment made to employees etc.
b.
Investing Activities:
The transactions
involving the purchase or sale of non-current assets are generally classified
as investing activities. It includes transactions involving long-lived assets
as well as lending of funds and the acquisition or sale of securities. It
involves cash inflows and outflows from acquiring and selling productive assets
such as plant and equipment, acquiring and selling investment securities,
lending money and collection on those loans and dividend received and interest
received from investments and loans given. For the like renting bicycles in the
summer and skis in the winter, investing activities involved are purchasing of bicycle and skis equipments,
sale of owned bicycle and skis equipments, etc.
c.
Financing Activities:
The transactions
involving raising funds for the firm from the owners and creditors are known as
financing activities, which also includes repaying creditors. These activities
include the issue of shares and various forms of debt and their repurchase or
repayment along with the payment of dividends to stockholders. However, the
transactions relating to stock dividend and stock splits and the payment of
interest are not financing activities. Business like renting bicycles in the
summer and skis in the winter, financing activities involved are issue share of
the company, taking and repayment of loan, paying dividend to its investors
etc.
5. What is accounting? Define it in terms
understandable to someone without a business background.
Accounting is called "the language of
business" because it is the vehicle for reporting financial information
about a business entity to many different groups of people. Accountancy is
the process of communicating financial information about a business
entity to users such as shareholders and managers.
The communication is
generally in the form of financial statements that show in
money terms the economic resources under the control
of management; the art lies in selecting the information that is relevant to
the user and is reliable.
In other word, accounting is the process of
identifying, measuring and communicating economic information to various users
including management of ttransactions that he company, stockholders, creditors,
financial analysts and government agencies. It can be considered as an
information system.
6. What are five different groups of users of
accounting information? Describe briefly the types of decisions each group must
make.
Users of accounting information can be categorized
mainly of two types: Internal Users and External Users.
a.
Internal Users:
Those directly involved
in the operations of the business are internal users. Internal users, primarily
the managers of a company, are involved in the daily affairs of the business. They
generate accounting information for their own consumption enabling them to
discharge their functions and for the benefits of external users. Management
accounting is the branch of accounting concerned with providing internal users
with information to facilitate planning and control.
b.
External Users:
External users, those
not directly involved in the operations of a business, need information that
differs from that needed by internal users. Financial accounting is the branch
of accounting concerned with communication with outsiders through financial
statements. The external users of accounting information are:
i. Stockholders and
potential stockholders:
The investors, both
current and potential need accounting information to know the business
positions, the profitability, the dividend payout capacity, the growth of
potential of the business, and performance in the stock market so that the
stockholders can take decisions either to retain, buy or sell the stock held by
them. The potential stockholders have to decide on their investments and there
are a number of options available to them. They use accounting information in
choosing competing investment possibilities.
ii. Bondholders,
Bankers and other creditors:
Before buying a bond in
a company, we need assurance that the company will be able to pay the amount
owed at maturity and the periodic interest payments. Financial statements can
help us to decide whether to purchase a bond or not. Similarly, before lending
money, a bank or creditors needs information that will help it determine the
company’s ability to repay both the amount of the loan and interest. Therefore,
a set of financial statements is a key ingredient in a loan proposal.
iii. Government
Agencies:
It needs information
specified by law like corporate tax, VAT, municipality tax, custom duties,
exercise duties, etc all requiring some basis for assessing the amount of tax.
Accounting provides most of the information required by tax authorities. Other
government agencies like the Department of Company Affairs, the Finance
Ministry, the Ministry of Trade and Industries require information for
regulating the business practices, the standards of products and services
provided, resource mobilization, providing grants and subsidies, etc.
iv. Consumers:
Consumers would like to
have information related to price, quality, products, reliability and delivery
dates. They also need information to know about the sales commitments in terms
of warranty, guarantee and after sales services of other kinds like supply of
spare parts and consumable items.
v.
Employees and their unions:
Employees and their
unions need accounting information for a number of reasons. The financial
statement data are used to fix wages, salary and bonus. They use accounting
information to evaluate the employer’s ability to honour long term commitments
like pension, gratuity and other retirement benefits.
vi.
General Public:
The
public at large are interested in the accounting information for a variety of
reason from employment policies, gender issues, environmental issues, social
issues, locality development, consumers’ rights, mobilization of resources, and
upliftment of the society and other wide range of issues.
7. What are the two distinct elements of owner's equity
in corporation? Define each element.
The two distinct elements of owners’ equity in
corporation are: contributed capital and retained earnings.
Contributed capital is simply the funds or capital
that is collected from various investors. It reflects the amounts
contributed by the owners to the company. Contributed capital is more commonly known as paid in capital. It can be a
separate account
within the stockholders' equity section of the balance sheet, or it can
be split between an additional
paid in capital account and a common stock account
(where the par value of
the shares
sold is recorded in the common stock account and any excess payments are
recorded in the additional paid in capital account), which are also within the
stockholders' equity section of the balance sheet.
Retained Earnings represents the owners’ claims to
the company’s assets that result from its earnings that have not been paid out
in dividends. It is the earnings accumulated or retained by the company. Retained
earnings are reported in the shareholders' equity section of the balance sheet.
8. What is the purpose of balance sheet?
Balance sheet is a financial statement that
summarizes the assets, liabilities and owners’ equity at a specific point in
time. The purposes of balance sheet are:
Ø It shows the financial position.
Ø It facilitates to assess the liquidity.
Ø It helps to judge the long term solvency.
Ø It can identify and analyze trends, particularly in
the area of receivables and payables.
9. How should a balance sheet be dated: as of a
particular day or for a particular period of time? Explain your answer.
A balance sheet is dated: as of a particular day or
for a particular period of time because the balance sheet shows the assets,
liabilities and shareholder’s equity which remains constant over a particular
period. These are not changes daily like an income and expenses. The balance
sheet shows the health of a business from day one to the date on the balance
sheet. Balance sheet is prepared monthly, quarterly, semi-annually and
annually. So, it shows the position of during that period.
10. What does the term cost principle mean?
Cost is expenditure, which is incurred in acquiring
an asset or service. The cost is an asset to the extent it is useful in future
or if it is un-expired. Expired cost is an expense and un-expired cost is an
asset. Accountants use the term historical cost to refer to the original cost
of an asset. Under current accounting standards, certain assets are valued at
historical cost on all balance sheets until the company disposes of them. The cost
principle is the general concept that we should only record an asset, liability,
or equity
investment at its original acquisition cost. This actual
cost is systematically reduced over its life by a process called depreciation. The
principle is widely used to record transactions,
partially because it is easiest to use the original purchase price as an
objective and verifiable evidence of value.
11. What is the purpose of an income statement?
Income statement summarizes the revenue and expenses
of a company for a period of time. The purposes of an income statement are:
Ø To find out the total sales, operating expenses,
cost of goods sold, gross profit, and other income and expenses;
Ø to report a company's earnings to investors
Ø it shows how the business makes its money
Ø Work as a primary source of information for the
firm’s current profit performance
Ø Help us to classify the income and expenses under
different heading
Ø Helps us to find out the taxable amount and taxes.
12. How should an income statement be dated: as of a
particular day or form a particular period of time? Explain your answer.
Income statement consists of sales/service revenue,
cost of goods sold, operating expenses, and other indirect income and expenses
that incurred over a period of time while carrying operating activities. Income
statement is dated as ‘as for a particular period of time’, because income
statement represents the profitability of the organization for some period of
time. Organization prepares income statement to know the profit during the
certain time interval. Income statement is also prepared at the end of the
accounting period as well as monthly, quarterly, and semi-annually.
13. Rogers Corporation starts the year with a Retained
Earnings balance of $55000. Net Income for the year is $27000. The ending
balance in Retained Earnings is $70000. What was the amount of dividends for
the year?
Statement of Retained Earning
Of Roger Corporation
As on ……………..
Details
|
Amounts
|
Opening
Balance
|
55,000
|
Add:
Net Income
|
27,000
|
Less:
Dividend
|
12,000
|
Ending Balance
|
70,000
|
14. What is the relationship between the cost principle
and the going concern assumption?
The cost
principle is the general concept that you should only record
an asset, liability,
or equity
investment at its original acquisition cost. The principle
is widely used to record transactions,
partially because it is easiest to use the original purchase price as an
objective and verifiable evidence of value.
Going concern is the assumption that an entity is
not in the process of liquidation and it will continue indefinitely into the
future. It uses historical cost rather than market value to report assets.
While recording business transactions in the books of accounts, it should be
assumed that business would be carried on indefinitely. This is why, the
businesses purchases fixed assets instead of hiring them. Consequently, the
treatment of purchase of goods is differentiated from the purchase of assets.
Hence, long-term expenses are termed as assets and are treated distinctly from
short term expenses. It is obligatory upon every accountant to treat business
activity as a continuing process and record transactions accordingly. Both cost
principle and the going concern assumption record the transaction on the basis
of costs.
15. What is meant by the term generally accepted
accounting principles?
Generally Accepted Accounting Principles (GAAP) refer to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards. GAAP includes the standards,
conventions, and rules accountants follow in recording and summarizing, and in
the preparation of financial
statements. GAAP are prescribed by authoritative bodies, such as the Financial
Accounting Standard Board (FASB), IASB, AICPA, ASB Nepal and are based on
theoretical as well as practical considerations. GAAP provide financial
statement users with assurances that financial statements are unbiased and help
users by increasing the comparability of financial statements between companies
and between accounting periods. It provides firms and accountants who prepare
financial statements with guidance on how to account for and report economic
activities. There are number of components of present GAAP, among them some
are: Accounting Entity Assumption, Going Concern Assumption, Money Measurement
Assumption, Accounting Period Assumption, Revenue Principle, Matching
Principle, Cost Principle, Dual Aspect Principle and Stable Monetary Unit
Principle.
Chapter 2
1. What does relevance mean with regard to the use of
accounting information?
Relevance is the capacity of information to make a
difference in a decision. Relevance implies that all those items of information
should be reported timely and should assist the users in forecasting future
financial performance or confirming past decisions. In general, the more useful
the information in decision-making the more relevant it is. Relevance depends
upon who the users are and what they want to forecast or confirm. It means that
information relevant for one person or purpose may not be necessarily as
important for other persons or purpose. In today’s complex financial accounting
environment, a general purpose report may not attend the common needs of all
users making the information relevant to all users.
2. What is the qualitative characteristic of
comparability?
Comparability allows comparisons to be made between
or among companies. Any information is considered comparable if it can be
related to a standard. The standard could be the data of same firm of the
previous year or the data of another firm. Using a common basis appropriate
intra-firm or inter-firm comparison can be made. Intra-firm comparisons are
made between results of the same firm for number of years and inter firm
comparisons are made between different firms having some common
characteristics. One important step towards comparability could be disclosure
of and adherence to accounting policies. The presentation of comparative
figures of previous year could be, another way of increasing comparability.
3. What is the difference between comparability and
consistency as they relate to the use of accounting information?
Comparability allows comparisons to be made between
or among companies. Whereas consistency means that financial statements can be
compared within a single company from one accounting period to the next.
Consistency is closely related to comparability. Both involve the relationship
between two numbers- comparability between numbers of different companies and
comparability the numbers of a single company for different periods. However, financial statements are comparable
when they can be compared between one company and another, statements are
consistent when they can be compared within a single company from one
accounting period to the next. In accounting, consistency has been used to
refer to the use of same accounting procedures by a single firm or accounting
entity from period to period, the use of similar measurement concepts and
procedures for related items within the statement of a firm for a single period
and the use of same procedure by different firms.
4. How does the concept of materiality relate to the
size of a company?
Materiality is closely related to relevance and
deals with the size of an error in accounting information. The issue is whether
the error is large enough to affect the judgment of someone relying on the
information. Information is material if its omission or misstatement could
influence the economic decision of
users taken on the basis of the financial statements. Materiality depends on
the size of the item or error judged in the particular circumstances of its
omission or misstatement. Thus, materiality provides a threshold or cut-off
point rather than being a primary qualitative characteristic which information
must have if it is to be useful.
5. How does the concept of the operating cycle relate
to the definition of a current asset?
The operating cycle is the length of time between
the purchase of merchandise for sale, assuming a retailer or wholesaler and the
eventual collection of the cash from the sale. Current assets are cash and
other assets that are reasonably expected to be realized in cash or consumed
during the normal operating cycle of a business or within one year if the
operating cycle is shorter than one year. Most businesses have an operating
cycle less than one year. Operating cycle involves cash, inventory and account
receivable. These all are recorded on the balance sheet under the current
assets because they are cash or will be realized in cash (account receivable)
or will be sold (inventory) within one year. So, the operating cycle is related
to the current assets.
6. State the primary objective of financial reporting
and the three secondary objectives.
The primary objective of financial reporting is to
provide economic information to permit users of the information to make
informed decisions. Three secondary objectives follow from the primary
objectives of financial reporting. They are as follows:
a.
Reflect Prospective Cash Receipts to Investors and
Creditors:
Investor: if I buy the
stock in this company, how much cash I will receive in the form of dividend or
from the sale of the stock.
Banker: if I lend money
to this company, how much cash I will receive in the form of interest and when
loan will be repaid.
b.
Reflect Prospective Cash Flows to the Company:
Investors, bankers and
others users ultimately care about their cash receipt, but this depends to some
extent on the company’s skills in managing its own cash flows.
c.
Reflect the Company’s Resources and Claims to its
Resources:
A company’s cash flows
are inherently tied to the information on the: balance sheet (assets,
liabilities and owners’ equity) and income statement (revenues and expenses).
7. List four qualities that make accounting information
useful.
The qualities that make accounting information
useful are:
a.
Understandability:
For anything to be
useful, it must be understandable. Understandability of financial information
varies considerably depending on the user’s background.
b.
Relevance:
Understandability alone
is certainly not enough to render information useful. To be useful, information
must be relevant. Relevance is the capacity of information to make a difference
in a decision. Relevance implies that all those items of information should be
reported timely.
c.
Reliability:
Reliability is the
quality which allows users of data to depend upon it with confidence.
Information is consider reliable if it posses the characteristics of faithful
representation, verifiability, completeness and neutrality.
d.
Comparability & Consistency:
Comparability is the
quality that allows a user to analyze two or more companies and look for
similarities and differences. Consistency is the quality that allows a user to
compare two or more accounting periods for a single company.
e.
Materiality:
Materiality is closely
related to relevance and deals with the size of an error in accounting
information that influence the decision. As per this convention only material
or important facts about the business activities are to be recorded and
communicated through financial statements.
f.
Conservatism:
Conservatism is the
practice of using the least optimistic estimate when two estimates of amounts are
about equally likely. It is an important characteristics and it mean a tendency
to play safe while presenting the information through financial statements.
8. How does a statement of retained earnings act as
link between an income statement and a balance sheet?
An income statement is prepared to find out the net
profit after tax. This net profit is transferred to the statement of retained
earnings to find out the available balance of retained earnings. After the
deduction of the dividend from the available balance of retained earnings,
ending balance of retained earnings is available. This ending balance of
retained earnings is transfer to the balance sheet on the liability and capital
side under the stockholders’ equity heading. Thus the statement of retained
earnings is act as a bridge between an income statement and a balance sheet.
Chapter 3
- What
are the two types of events that affect an entity? Describe each.
An event is an occurrence having financial
implications which have a bearing on the finance of the reporting entity like
depreciation, loss of goods by fire, etc. The two types of events that affect
an entity are:
- External events:
An external event involves interaction between the
entity and its environment. For example, the payment of wages to an employee is
an external event, as is a sale to a customer.
- Internal Event:
An internal event occurs entirely within the entity.
The use of piece of equipment is an internal event.
Both of these different types of events affect an
entity and are usually recorded in accounting system as a transaction.
- Stockholders'
equity represents the claim of the owners on the assets of the business.
What is the distinction relative to the owners' claim between the Capital
Stock account and the Retained Earnings account?
Stockholders are the real owners of the business.
Stockholders’ equity represents the amount of investment made by the owners’.
So, they have the claim on the assets of the business.
Capital stock is simply the funds or capital
that is collected from various investors. The claim of the owners over the
capital stock is limited up to the amount they invested in all periods. It
reflects the amounts contributed by the owners to the company. Capital stock is more commonly known
as paid in capital. It can
be a separate account
within the stockholders' equity section of the balance sheet.
Retained Earnings represents the owners’ claims to
the company’s assets that result from its earnings that have not been paid out
in dividends. It is the earnings accumulated or retained by the company. The
claim of the owners over retained earnings varies in amount in different
intervals of time. Retained earnings are reported in the shareholders' equity section of
the balance sheet.
- What
is the purpose of trial balance?
Trial Balance is a list of closing balances of
ledger accounts on a certain date and is the first step towards the preparation
of financial statements. It is usually prepared at the end of an accounting
period to assist in the drafting of financial statements. Its
main purpose is to check mathematical\arithmetic accuracy of
accounting as well as to find out whether the debit balance is equals to the
credit balance or not. Some other purposes are:
Ø Trial Balance acts as the first step in the
preparation of financial statements.
Ø Trial balance ensures that the account balances are
accurately extracted from accounting ledgers.
Ø Trail balance assists in the identification and
rectification of errors.
Ø Trial balance helps in making adjustments.
- Explain
how an external event differs from an internal event.
An external event involves interaction between the
entity and its environment (external components). The external events are
beyond the control and provide opportunities and threats to the organization.
For example, the payment of wages to an employee is an external event, as is a
sale to a customer.
An internal event occurs entirely within the entity.
The internal events are under the control of the organization and provide the
strength and weakness of the organization. The use of piece of equipment is an
internal event.
Both of these different types of events affect an
entity and are usually recorded in accounting system as a transaction.
- Provide
three examples of source documents and the event for which each would
provide the evidence to record.
A source documents is a piece of paper that is used
as evidence to record a transaction. Source documents are the basis for
recording transactions. They take many different forms, such as invoices, cash
registers tapes and time card. An invoice received from a supplier is the
source document for a purchase of inventory on credit. A cash register tapes is
the source document used by retailer to recognize a cash sale. The payroll department
sends the accountant the time cards for the week as the necessary documentation
to record wages. Other source documents are:
credit bills which provides evidence about the
credit sales, deposit slips provides evidence about the amount deposited into the
bank, bank statement provides the evidence about the available balance in the
bank account as well as withdrawals, receipts provides information about the
cash received, stock certificate provides information about the ownership of a
specific number of shares of stock in a corporation.
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