Chapter 5, Problem 1P

To determine

Match the transaction or definition with its related concept.

Answer to Problem 1P

Indication of transaction or definition with its related concept as given below:

Concepts	Transaction or Definition
(1) Users of financial statements	E. The investors, creditors, and others interested in the business.
(2) Objective of financial statements	L. To design and prepare the financial statements to assist the users in making decisions.
Qualitative Characteristics
(3) Relevance	D. Reported the amount of depreciation expense because it likely will affect statement users’ decision making.
(4) Reliability	I. Engaged an outside independent CPA to audit the financial statements.
Assumptions
(5) Separate entity	M. Established a policy not to include in the financial statements the personal financial affairs of the owners of the business.
(6) Continuity	W. Accounting and reporting assume a “going concern.”
(7) Unit of measure	B. Counted (inventoried) the unsold items at the end of the period and valued them in dollars.
(8) Time period	Q. Dated the income statement “For the Year Ended December 31, 2017.”
Elements of financial statements
(9) Revenues	A. Recorded a $2,000 sale of merchandise on credit.
(10) Expenses	H. Used services from outsiders; paid cash for some and put the remainder on credit.
(11) Gains	U. Sold an asset at a gain that was a peripheral or incidental transaction.
(12) Losses	J. Sold an asset at a loss that was a peripheral or incidental transaction.
(13) Assets	C. Acquired a vehicle for use in operating the business.
(14) Liabilities	G. Sold and issued bonds payable of $3 million.
(15) Stockholders’ equity	V. $\begin{array}{l}\text{Stockholders' equity}=\text{ Assets}-\text{Liabilities}\\ \text{Stockholders' equity}=\text{\$600,000}-\text{\$400,000}\\ \text{Stockholders' equity}=\$200,000\end{array}$
Principles
(16) Cost	R. Paid a contractor for an addition to the building with $15,000cash and $20,000 market value of the stock of the company ($35,000 was deemed to be the cash-equivalent price).
(17) Revenue	K. Established an accounting policy that sales revenue shall be recognized only when ownership to the goods sold passes to the customer.
(18) Matching	N. Sold merchandise and services for cash and on credit during the year; then determined the cost of those goods sold and the cost of rendering those services.
(19) Full disclosure	T. Disclosed in the financial statements all relevant financial information about the business; necessitated the use of notes to the financial statements.
Constraints of Accounting
(20) Materiality threshold	S. Acquired an asset (a pencil sharpener that will have a useful life of five years) and recorded it as an expense when purchased for $1.99.
(21) Cost-effectiveness	O. The user value of a special financial report exceeds the cost of preparing it.
(22) Conservatism constraint	P. Valued an asset, such as inventory, at less than its purchase cost because the replacement cost is less.
(23) Special industry practices	F. Used special accounting approaches because of the uniqueness of the industry.

Table (1)

Explanation of Solution

Users of financial statements: The people interested in making decisions about the company through financial statements are investors and creditors. Some of the various users are as follows:

• Creditors: Creditors (lenders) are the persons who make decisions on lending money to the company.
• Institutional Investors are the individuals or group of persons who decides to invest in pension funds (allied with companies, unions, or government agencies), mutual funds on behalf of others.
• Private Investors are the individuals or group of persons who purchase the shares of the publicly traded companies.

Objectives of financial statements: The objective of financial statement is to enable the various users to take informed decisions through the evaluation of various financial statements such as balance sheet, statement of income, statement of stockholders’ equity and statement of cash flows.

Relevance: The financial statement prepared should indicate the affirmatory value or supporting value. The important components of relevant information are Predictive value Confirmatory value and Materiality.

Separate entity assumption: Business is considered as an individual entity, as per the economic entity assumption, hence it indicates the business and personal record keeping should be maintained separately.

Continuity assumption: The going concern assumption emphasizes on the longevity of the company’s life. This assumption is based on the anticipation of the indefinite continuation of the business operation.

Unit of measure assumption: Monetary unit assumption is based on the assumption, that the dollar is stable and will have a purchasing power for a long term; hence it assumes that the dollar is “measuring stick” used to report financial performance.

Time period assumption: Periodicity assumptions give way to divide the business activities, into smaller periods for accounting convenience; hence it separates accounting information into time periods for reporting purposes.

Revenues: Revenue refers to the income received from the business activity or sale of the output, during the accounting period.

Expenses: Expenses refer to the cost incurred on the necessary purchases of the fixed assets by the firm, or the production of the goods and services, during the accounting period.

Gains: Gain can be defined as the revenue exceeding the expenses, this increases the equity.

Losses: Loss can be defined as the expenses exceeding the revenue, this decreases the equity.

Asset: Assets refer to the resources owned by the business, which are utilized in the course of the business to generate revenue.

Liability: Liabilities include the claims of the creditors on the assets of the business. The liability is the obligation of the business.

Stockholders’ Equity: Stockholders Equity refers to the right the owner possesses over the resources of the business. Common stock and the retained earnings are the components of the Stockholders Equity. The stockholders’ equity can also be termed as the difference between assets and liabilities (using the accounting equation) as shown in the given formula:

$\begin{array}{l}\boxed{\text{Assets = Liabilities + Stockholders' Equity}}\\ \boxed{\text{Stockholders' Equity = Assets}-\text{Liabilities }}\end{array}$

Cost principle: Historical cost principle insists on recording the assets, on its original cost in the balance sheet; hence it indicates that the fair value, changes subsequent to purchases is not recorded in the accounts.

Revenue Recognition Principle: Revenue Recognition Principle emphasizes, that the revenue and incurrence of related service must pertain to same period; hence it requires the recognition of revenue, in the same period as the service is provided. The revenue received in advance, should not be included under the revenues in income statement, as the service is yet to be provided, and the revenue, though received has not been actually earned.

Matching principle: Expense recognition principle emphasizes that the expense and related revenue must pertain to same period; hence it requires the recognition of expenses in the same period as related revenues.

Full disclosure principle: Full disclosure principle ensures, all financial information relating to the company are recorded; hence all financial information is reported.

Cost effectiveness: Cost effectiveness constraint states that the main benefit of accounting is to assist with decision making.  The information provided helps the investors and creditors on making better decisions.