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

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif::::/sites/dl/free/0072994029/0073130087_001_0595.gif','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

In addition, you learn that the company incurred utility costs of $35,000 in year one, that there were no liabilities at the end of year two, no anticipated bad debts on receivables, and that the insurance policy covers a three-year period.

Required:

1. Calculate the net operating cash flow for years 1 and 2.
2. Prepare an income statement for each year similar to Illustration 1-2 according to the accrual accounting model.
3. Determine the amount of receivables from customers that the company would show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.

E1-1
Accrual accounting

lLO2

Listed below are several transactions that took place during the second two years of operations for RPG Consulting.

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In addition, you learn that the company incurred advertising costs of $25,000 in year 2, owed the advertising agency $5,000 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 the RPG’s balance sheet at the end of year 2.

E 1-2
Accrual accounting

lLO2

Different organizations historically and currently have issued various pronouncements that constitute the body of generally accepted accounting principles. Presented below are some of these organizations as well as various authoritative pronouncements. Match each organization with the one or more pronouncement(s) with which it is associated.

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E 1-3
Sources of GAAP

lLO3

Three groups that participate in the process of establishing GAAP are users, preparers, and auditors. These groups are represented by various organizations. For each organization listed below, indicate which of these groups it primarily represents.

1. Securities and Exchange Commission
2. Financial Executives International
3. American Institute of Certified Public Accountants
4. Institute of Management Accountants
5. Association of Investment Management and Research

E 1-4
Participants in establishing GAAP

lLO3

For each of the items listed below, identify the appropriate financial statement element or elements.

1. Obligation to transfer cash or other resources as a result of a past transaction.
2. Dividends paid by a corporation to its shareholders.
3. Inflow of an asset from providing a good or service.
4. The financial position of a company.
5. Increase in equity during a period from nonowner transactions.
6. Increase in equity from peripheral or incidental transaction.
7. Sale of an asset used in the operations of a business for less than the asset’s book value.
8. The owners’ residual interest in the assets of a company.
9. An item owned by the company representing probable future benefits.
10. Revenues plus gains less expenses and losses.
11. An owner’s contribution of cash to a corporation in exchange for ownership shares of stock.
12. Outflow of an asset related to the production of revenue.

E 1-5
Financial statement elements

lLO6, LO6, LO6

Listed below are several terms and phrases associated with the FASB’s conceptual framework. Pair each item from List A (by letter) with the item from List B that is most appropriately associated with it.

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E 1-6
Concepts; terminology; conceptual framework

lLO6, LO6, LO6

The following questions dealing with the FASB’s conceptual framework are adapted from questions that appeared on CPA examinations. Determine the response that best completes the statements or questions.

1. According to the FASB conceptual framework, which of the following situations violates the concept of reliability?
1. Data on segments having the same expected risk and growth rates are reported to analysts estimating future profits.
2. Financial statements are issued nine months late.
3. Management reports to stockholders regularly refer to new projects undertaken, but the financial statements never report project results.
4. Financial statements include property with a carrying amount increased to management’s estimate of market value.
2. According to Statements of Financial Accounting Concepts, neutrality is an ingredient of

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif::::/sites/dl/free/0072994029/0073130087_001_0635.gif','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

3. According to the FASB conceptual framework, predictive value is an ingredient of

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4. According to the FASB conceptual framework, earnings
1. Are the same as comprehensive income.
2. Exclude certain gains and losses that are included in comprehensive income.
3. Include certain gains and losses that are excluded from comprehensive income.
4. Include certain losses that are excluded from comprehensive income.
5. According to the FASB conceptual framework, which of the following relates to both relevance and reliability?

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif::::/sites/dl/free/0072994029/0073130087_001_0637.gif','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

E 1-7
Multiple choice; conceptual framework

lLO6, LO6, LO6

Listed below are several terms and phrases associated with basic assumptions, underlying principles, and constraints. Pair each item from List A (by letter) with the item from List B that is most appropriately associated with it.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif::::/sites/dl/free/0072994029/0073130087_001_0638.gif','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

E 1-8
Basic assumptions, principles, and constraints

lLO6, LO6, LO6, LO7, LO8

Listed below are several statements that relate to financial accounting and reporting. Identify the basic assumption, broad accounting principle, or pervasive constraint that applies to each statement.

1. Jim Marley is the sole owner of Marley’s Appliances. Jim borrowed $100,000 to buy a new home to be used as his personal residence. This liability was not recorded in the records of Marley’s Appliances.
2. Apple Computer, Inc., distributes an annual report to its shareholders.
3. Hewlett-Packard Corporation depreciates machinery and equipment over their useful lives.
4. Crosby Company lists land on its balance sheet at $120,000, its original purchase price, even though the land has a current market value of $200,000.
5. Honeywell Corporation records revenue when products are delivered to customers, even though the cash has not yet been received.
6. Liquidation values are not normally reported in financial statements even though many companies do go out of business.
7. IBM Corporation, a multibillion dollar company, purchased some small tools at a cost of $800. Even though the tools will be used for a number of years, the company recorded the purchase as an expense.

E 1-9
Basic assumptions and principles

lLO6, LO6, LO6, LO7, LO8

Identify the basic assumption or broad accounting principle that was violated in each of the following situations.

1. Pastel Paint Company purchased land two years ago at a price of $250,000. Because the value of the land has appreciated to $400,000, the company has valued the land at $400,000 in its most recent balance sheet.
2. Atwell Corporation has not prepared financial statements for external users for over three years.
3. The Klingon Company sells farm machinery. Revenue from a large order of machinery from a new buyer was recorded the day the order was received.
4. Don Smith is the sole owner of a company called Hardware City. The company recently paid a $150 utility bill for Smith’s personal residence and recorded a $150 expense.
5. Golden Book Company purchased a large printing machine for $1,000,000 (a material amount) and recorded the purchase as an expense.
6. Ace Appliance Company is involved in a major lawsuit involving injuries sustained by some of its employees in the manufacturing plant. The company is being sued for $2,000,000, a material amount, and is not insured. The suit was not disclosed in the most recent financial statements because no settlement had been reached.

E 1-10
Basic assumptions and principles

lLO7, LO8

For each of the following situations, indicate whether you agree or disagree with the financial reporting practice employed and state the basic assumption, pervasive constraint, or accounting principle that is applied (if you agree) or violated (if you disagree).

1. Wagner Corporation adjusted the valuation of all assets and liabilities to reflect changes in the purchasing power of the dollar.
2. Spooner Oil Company changed its method of accounting for oil and gas exploration costs from successful efforts to full cost. No mention of the change was included in the financial statements. The change had a material effect on Spooner’s financial statements.
3. Cypress Manufacturing Company purchased machinery having a five-year life. The cost of the machinery is being expensed over the life of the machinery.
4. Rudeen Corporation purchased equipment for $180,000 at a liquidation sale of a competitor. Because the equipment was worth $230,000, Rudeen valued the equipment in its subsequent balance sheet at $230,000.
5. Davis Bicycle Company received a large order for the sale of 1,000 bicycles at $100 each. The customer paid Davis the entire amount of $100,000 on March 15. However, Davis did not record any revenue until April 17, the date the bicycles were delivered to the customer.
6. Gigantic Corporation purchased two small calculators at a cost of $32.00. The cost of the calculators was expensed even though they had a three-year estimated useful life.
7. Esquire Company provides financial statements to external users every three years.

E 1-11
Basic assumptions and principles

lLO6, LO6, LO6, LO7, LO8

Listed below are the basic assumptions, underlying principles, and constraints discussed in this chapter.

1. Economic entity assumption
2. Going concern assumption
3. Periodicity assumption
4. Monetary unit assumption
5. Historical cost principle
6. Realization principle
7. Matching principle
8. Full-disclosure principle
9. Cost effectiveness
10. Materiality
11. Conservatism

Identify by letter the assumption, principle, or constraint that relates to each statement or phrase below.

_____ 1. Revenue is recognized only after certain criteria are satisfied.

_____ 2. Information that could affect decision making should be reported.

_____ 3. Cause-and-effect relationship between revenues and expenses.

_____ 4. The basis for measurement of many assets and liabilities.

_____ 5. Relates to the qualitative characteristic of timeliness.

_____ 6. All economic events can be identified with a particular entity.

_____ 7. The benefits of providing accounting information should exceed the cost of doing so.

_____ 8. Aconsequence is that GAAPneed not be followed in all situations.

_____ 9. Not a qualitative characteristic, but a practical justification for some accounting choices.

_____ 10. Assumes the entity will continue indefinitely.

_____ 11. Inflation causes a violation of this assumption.

E 1-12
Basic assumptions, principles, and constraints

lLO6, LO6, LO6, LO7, LO8

Determine the response that best completes the following statements or questions.

1. The primary objective of financial reporting is to provide information
1. About a firm’s economic resources and obligations.
2. Useful in predicting future cash flows.
3. Concerning the changes in financial position resulting from the income-producing efforts of the entity.
4. About a firm’s financing and investing activities.
2. Statements of Financial Accounting Concepts issued by the FASB
1. Represent GAAP.
2. Have been superseded by SFASs.
3. Are subject to approval of the SEC.
4. Identify the conceptual framework within which accounting standards are developed.
3. In general, revenue is recognized as earned when the earning process is virtually complete and
1. The sales price has been collected.
2. A purchase order has been received.
3. There is reasonable certainty as to the collectibility of the asset to be received.
4. A contract has been signed.
4. In depreciating the cost of an asset, accountants are most concerned with
1. Conservatism.
2. The realization principle.
3. Full disclosure.
4. The matching principle.
5. The primary objective of the matching principle is to
1. Provide full disclosure.
2. Record expenses in the period that related revenues are recognized.
3. Provide timely information to decision makers.
4. Promote comparability between financial statements of different periods.
6. The separate entity assumption states that, in the absence of contrary evidence, all entities will survive indefinitely.
1. True
2. False

E 1-13
Multiple choice; concept statements, basic assumptions, principles

lLO5, LO6, LO6, LO6, LO7, LO8

The following questions dealing with the environment and theoretical structure of financial accounting are adapted from questions that previously appeared on Certified Management Accountant (CMA) examinations. The CMA designation sponsored by the Institute of Management Accountants (www.imanet.org) provides members with an objective measure of knowledge and competence in the field of management accounting. Determine the response that best completes the statements or questions.

1. Accounting standard setting in the U.S. is
1. Done primarily by the Securities and Exchange Commission.
2. Done primarily by the private sector.
3. The responsibility of the public sector.
4. Done primarily by the International Accounting Standards Committee.
2. Reliability as used in accounting includes
1. Determining the revenue first, then determining the costs incurred in earning that revenue.
2. The entity’s giving the same treatment to comparable transactions from period to period.
3. Similar results being obtained by both the accountant and an independent party using the same measurement methods.
4. The disclosure of all facts that may influence the judgment of an informed reader.
3. Recognition is the process of formally recording and reporting an item in the financial statements. In order for a revenue item to be recognized, it must be all of the following except
1. Measurable.
2. Relevant.
3. Material.
4. Realized or realizable.

E 1-14
Multiple choice; CMA exam; concepts

lLO3, LO6, LO6, LO6