Answer Key Chapter 5 Principles of Accounting, Volume 1: Financial Accounting

The information will be timely and current and will give a meaningful picture of how the company is operating. In applying their conceptual framework to create standards, the IASB must consider that their standards are being used in 120 or more different countries, each with its own legal and judicial systems. This means that IFRS interpretations and guidance have fewer detailed components for specific industries as compared to US GAAP guidance.

  • Cost Benefit Principle – limits the required amount of research and time to record or report financial information if the cost outweighs the benefit.
  • All Integrity Network members are paid members of the Red Ventures Education Integrity Network.
  • Industry Practices Constraint – some industries have unique aspects about their business operation that don’t conform to traditional accounting standards.
  • This is because closing requires that the account balances be cleared, to prepare for the next accounting period.
  • The generally accepted accounting principles (GAAP) are a set of accounting rules, standards, and procedures issued and frequently revised by the Financial Accounting Standards Board (FASB).

International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB). The full disclosure principle is one of the most important accounting principles. The application of the materiality principle can be complex, but it is essential to ensure the accuracy of financial statements. The materiality principle is one of the most important accounting principles.

Where Are Generally Accepted Accounting Principles (GAAP) Used?

You should list the historical costs of the property as the cost, instead of the fair market value of the property. Bear in mind any overhead costs you might be forgetting when factoring in this accounting term. Finally, outsourcing accounting services can provide businesses with access to the latest accounting software and technology. This can help businesses to streamline their financial management processes and reduce the risk of errors. Hiring a chartered accountant or outsourcing an accounting service can bring several benefits to a company. Firstly, they can provide businesses with expert financial advice and help them to manage their finances more effectively.

They can also ensure that businesses comply with financial regulations and avoid any legal issues. This refers to recording your assets at their original cost rather than their current market value. Doing this allows you to properly record depreciation for purchased assets  orderly. By adhering to this principle, you can prevent from overstating business assets and present a more accurate picture of  its financial position. In historical cost accounting, the accounting data are verifiable since the transactions are recorded on the basis of source documents such as vouchers, receipts, cash memos, invoices, etc.

Full Disclosure Principle

For instance, when the COVID-19 pandemic hit, the board members met to address how governments and businesses must report the financial effects of the pandemic. The information on financial statements should be complete so that nothing is misleading. With this intention, important partners or clients will be aware of relevant information concerning your company. CAs, experts and businesses can get GST ready with Clear GST software & certification course.


Revenues are to be recognized (reported) on a company’s income statement when they are earned. Therefore, a company will report some revenues on its income statement before a customer pays for the goods or services it has received. In the case of cash sales, revenues will be reported when customers pay for their merchandise. If customers pay in advance, the revenues will be recognized (reported) after the money was received. For U.S. companies, the monetary unit assumption allows accountants to express a company’s wide-ranging assets as dollar amounts.

What is GAAP?

This means that FASB has only one major legal system and government to consider. This means that interpretation and guidance on US GAAP standards can often contain specific details and guidelines in order to help align the accounting process with legal matters and tax laws. For financial statements to be relevant they should be distributed as soon as possible after the end of the accounting period. The Great Depression in 1929, a financial catastrophe that caused years of hardship for millions of Americans, was primarily attributed to faulty and manipulative reporting practices among businesses. In response, the federal government, along with professional accounting groups, set out to create standards for the ethical and accurate reporting of financial information.

Since liabilities, equity (such as common stock), and revenues increase with a credit, their “normal” balance is a credit. The basic components of even the simplest accounting system are accounts and a general ledger. An account is a record showing increases and decreases to assets, liabilities, and equity—the basic components found in the accounting equation. As you know from Introduction to Financial Statements, each of these categories, in turn, includes many individual accounts, all of which a company maintains in its general ledger.

Privately held companies and nonprofit organizations also may be required by lenders or investors to file GAAP-compliant financial statements. For example, annual audited GAAP financial statements are a common loan covenant required by most banking institutions. Therefore, most companies and organizations in the U.S. comply with GAAP, even though it is not a legal requirement. Before implementing the different types of accounting principles in your accounting processes, it is important to know the characteristics of such principles. The cost principle makes recording assets and liabilities easy, offers objective proof of transactions like sales receipts, bank reconciliation or invoices. Revenue – The representation of the money a business has earned in sales during an accounting period, revenue is calculated by subtracting the business costs from the total revenue.

This principle states that any accountant or accounting team hired by a company is obligated to provide the most unbiased, accurate financial report possible. Although a business may be in a bad financial situation, one that may even compromise its future, the accountant may only report on the situation as it is. If a financial statement is not prepared using GAAP, investors should be cautious. Without GAAP, comparing financial statements of different companies would be extremely difficult, even within the same industry, making an apples-to-apples comparison hard. Some companies may use both GAAP and non-GAAP measures when reporting their financial results.

This would mean that any uncertain or estimated expenses/losses should be recorded, but uncertain or estimated revenues/gains should not. This gives stakeholders a more reliable view of the company’s financial position and does not overstate income. As illustrated in this chapter, the starting point for either FASB or IASB in creating accounting standards, or principles, is the conceptual framework. Both FASB and IASB cover the same topics in their frameworks, and the two frameworks are similar. The conceptual framework helps in the standard-setting process by creating the foundation on which those standards should be based. It can also help companies figure out how to record transactions for which there may not currently be an applicable standard.

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