1.The conceptual framework of accounting is the collection of general concepts that logically flow from

1.The conceptual framework of accounting is the collection of general concepts that logically flow from the objective of financial reporting—to provide information that is useful in making business and economic decisions. The conceptual framework supports the development of generally accepted accounting principles (GAAP) and provides a consistent body of thought for financial reporting. An understanding of the conceptual framework will provide a logical structure to financial accounting that will help in understanding complex accounting standards.

2.The conceptual framework identifies two fundamental qualitative characteristics—relevance and faithful representation. Relevant information is capable of making a difference in a decision by helping users predict future events or providing feedback about prior expectations. Relevant information is also material. Faithfully represented information portrays the economic event it intends to portray. Faithfully represented information should be complete (includes all necessary information for the user to understand the economic event), neutral (unbiased), and free from error (as accurate as possible).In addition to the fundamental qualitative characteristics, the FASB has identified four enhancing characteristics—comparability, verifiability, timeliness, and understandability. Comparable information allows external users to identify similarities and differences between two or more items.Comparability includes consistency, which can be achieved by a company applying the same accounting principles for the same items over time. Verifiable information describes a situation in which independent parties can reach a consensus on the measurement of the activity. Information is timely if it is available to users before it loses its ability to influence decisions. Finally, if users who have a reasonable knowledge of accounting and business can, with reasonable study effort, comprehend the meaning of the information, it is considered understandable.

3.Tradeoffs are often necessary between the qualitative characteristics. For example, the most relevant information may not be able to be faithfully represented. Similarly, a change in accounting principle may temporarily reduce comparability but improve the relevance of the information. The goal should be to provide the most relevant information that can be faithfully represented.

4.Comparability refers to the ability to compare information across different companies or with similar information about the same company for another time period. Consistency refers to the use of the same accounting principles for the same items, either from one time period to another time period within a company or in a single period across companies.

5.The cost constraint limits the ability of a company to provide useful information. The cost constraint refers to the idea that some information that is useful would be too expensive for the company to provide based on the benefit that is achieved from providing it.

6.The four underlying accounting assumptions are the economic entity assumption, continuity (going- concern) assumption, time-period assumption, and monetary unit assumption. The economic entity assumption requires that a company be accounted for separately from its owners. The continuity assumption assumes that a company will continue to operate long enough to carry out its existing commitments. The time-period assumption allows the life of a company to be divided into artificial time periods so net income can be measured for a specific period of time. The monetary unit assumption requires that a company account for and report its financial results in monetary terms.2

THE ACCOUNTING

INFORMATION SYSTEM

DISCUSSION QUESTIONS

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CHAPTER 2 The Accounting Information System 7.There are four principles used to measure and record business transactions. First, the historical cost principle requires transactions to be recorded at their cost—the exchange price at the time the activity occurs. Second, the revenue recognition principle determines when revenue is recorded and reported by a company. Under this principle, revenue must be earned and the collection of cash must be reasonably assured in order to record and report revenue. Third, the expense recognition (or matching) principle requires that an expense be recorded and reported in the same period as the revenue it helped generate. This may or may not be in the same period that cash is paid. Finally, the conservatism principle states that accountants should take care to avoid overstating assets or income.

8.The financial statements summarize the economic performance and status of a business and are issued at least annually. Generally accepted accounting principles (GAAP) are the rules and conventions that guide the preparation of financial statements. GAAP provides a “common ground” that makes it easier to use financial statements over time and across companies.

9.Many events occur that affect the financial position and the operations of a business, but only those that qualify for recognition as transactions are recorded in the accounting records.To qualify as a transaction, the effect of the underlying events must impact a financial statement element (asset, liability, stockholders’ equity, revenue, or expense) and, thus, the company’s financial statements. In addition, the event must be able to be faithfully represented.

10.Faithful representation refers to information faithfully representing the economic event that it is intending to portray. Faithfully presented information should be complete, neutral, and free from error. If information is not faithfully represented, it may mislead decision-makers. These decision-makers would find it extremely difficult, if not impossible, to use information that is incomplete or subject to significant error and/or bias.

11.Transaction analysis usually begins with gathering the source documents that describe business activities. Accountants must then analyze these documents to determine which transactions should be recognized in the accounting system. If the transaction is to be recorded in the accounting system, the transaction must then be analyzed to determine the effects it will have on the fundamental accounting equation. This analysis involves three steps: (1) write down the accounting equation; (2) identify the financial statement elements that are affected by the transaction; and (3) determine whether the element increased or decreased.

12.Yes, it is possible for a transaction to affect only one side of the accounting equation. While the accounting equation must always remain in balance (meaning there must always be a dual effect on the accounting equation), these effects can be on the same side of the accounting equation. An example of this is when a customer pays cash for an accounts receivable. Both cash and accounts receivable are asset accounts (on the left side of the equation). One asset, accounts receivable, is decreasing, while another asset, cash, is increasing by the same amount. This results in the accounting equation remaining in balance, even though only one side of the equation was affected.

13.When a firm earns revenue, its net income is increased. When a firm incurs an expense its net income is decreased. At the end of the accounting period, net income is added to retained earnings, a stockholders’ equity account. Therefore, an increase in revenue increases stockholders’ equity and a decrease in revenue decreases stockholders’ equity. Likewise, an increase in expense decreases stockholders’ equity and a decrease in expense increases stockholders’ equity.2-2 © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 The Accounting Information System 14.A T-account is a two-column record that consists of a title and two sides divided by a vertical line. A T-account gets its name because it resembles the capital letter “T.” The left side is referred to as the debit side, and the right side is referred to as the credit side.

15.No, debit does not mean increase and credit does not mean decrease. The words debit and credit simply refer to the left and right side of an account. Neither debit nor credit has direct positive or negative connotations. Only when the terms debit and credit are associated with a particular account can a debitor a creditbe identified as an increase or a decrease.For example, a debit increases an asset account but decreases a liability account.

16.To debit an account means to add an amount to the left side of that account. A debit balance is a balance on the left side of an account. To credit an account means to add an amount to the right side of that account. A credit balance is a balance on the right side of an account.Debits and credits do not represent increases or decreases.

17.The normal balance of each of the accounts is:

(a) cash—debit (b) sales—credit (c) notes payable—credit (d) inventory—debit (e) retained earnings—credit (f) salary expense—debit (g) equipment—debit (h) unearned revenue—credit 18.In each journal entry, the sum of the debits must equal the sum of the credits. If transactions are recorded with debits equal to credits, then the equality of the accounting equation will be maintained.

19.Accounting transactions are typically recorded initially in a journal on an event-by-event basis.The recording of events in a journal allows the entire effect of a transaction to be contained in one place. The individual effects of a transaction are then posted to the general ledger.Potentially, a firm could put these transactions directly into the general ledger. However, if the transaction were recorded directly into the general ledger, there would be no evidence of the complete transaction in one place, which would make the use of the information very cumbersome.

20.“Double-entry” is an appropriate description of an accounting system because each transaction will affect at least two accounts and each transaction must have debit and credit entries that must be equal.

21.The initial steps of the accounting cycle involve (1) analyzing transactions; (2) journalizing transactions; (3) posting to the general ledger; and (4) preparing a trial balance. In the first step, data is collected about business activities and analyzed to determine which activities meet the criteria for recognition in the accounting records. If the data meet the recognition criteria, the effect on the fundamental accounting equation is determined. In the second step, the effects of the transaction on the fundamental accounting equation are recorded in the accounting system using debits and credits. In the third step, journal entries are posted to the general ledger, which is organized on an account-by-account basis. Finally, a trial balance is prepared from account balances in the ledger.

22.Trial balances help detect errors resulting from inequality of debits and credits. A trial balance usually will not help in the detection of omitted entries or errors of analysis, journalizing, or posting when those errors cause incorrect account balances with equal debits and credits.2-3 © 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 The Accounting Information System 2-1. c 2-2. d 2-3. c 2-4. b 2-5. a

2-6. d 2-7. c 2-8. a 2-9. d 2-10. a 2-11. c 2-12. a 2-13. d 2-14. a 2-15. b

MULTIPLE-CHOICE QUESTIONS

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