Learning Questions and Answers for Financial Accounting, Lesson 2.2 – Mastery Level

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(1) – Financial accounting has literally thousands of pages of official rules. Why does financial accounting have so many rules?

(2) – Do rigid accounting rules exist for every possible type of reporting situation?

(3) – What are these accounting rules called?

(4) – Who is in charge of creating or modifying U.S. GAAP?

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(5) – Is U.S. GAAP used throughout the business world even outside of the United States?

(6) – Who creates and modifies IFRS?

(7) – In general, what is the difference in how U.S. GAAP was developed and how IFRS was developed?

(8) – How similar is U.S. GAAP to IFRS?

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(9) – In Chapter Two of the textbook, a quote is presented from a Wall Street Journal article, “When the intellectual achievements of the 20th century are tallied, GAAP should be on everyone’s Top 10 list.” That seems ridiculous. How could U.S. GAAP be so vital to our world?

(10) – One of the most important things that an organization can report to decision makers is information about its assets. What is an asset?

(11) – In describing an asset, the term “probable future economic benefit” is used. What does that term mean?

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12) – What are examples of assets that an organization might report within its financial information?

(13) – What is a liability?

(14) – What does the term “net assets” mean?

(15) – A company reports earning revenue of $6.3 million during the past year. That is financial information. What is revenue?

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(16) – A company reports expenses of $4.7 million during the past year. What does this statement indicate to a decision maker?

(17) – You start a business. You plan to hire friends and provide lawn care to your neighbors. What might be some of your expenses?

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This concludes our basic questions for Chapter Two. These include facts and other information that you might never have considered before you started this course. Nevertheless, there is nothing in any of these questions that you cannot learn. Some of the terminology might be new to you but it is certainly not impossible to learn every answer with a few repetitions. Get to work. Let’s learn this material and move on to our next chapter.

Here are the answers to the questions.

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(1) – Financial accounting has literally thousands of pages of official rules. Why does financial accounting have so many rules?

There are several reasons for the tendency of financial accounting to rely on rules. First, the rules provide guidance to organizations on how financial information should be reported. Many business transactions and events can be extremely complex. With extensive rules available, company officials do not have to make up their own procedures and processes. In most cases, rules have already been established to dictate an appropriate method of reporting. Second, financial decision makers are scattered all over the world and have varying degrees of business acumen. Having a standard set of accounting rules in place helps to enable every decision maker to better understand provided information and, hence, have a greater chance to make wise decisions. Third, comparisons between organizations are easier to draw if each one is required to follow the same rules.

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(2) – Do rigid accounting rules exist for every possible type of reporting situation?

No. Some reporting issues are so inconsequential that formal rules have never been developed. In other cases, official rules are present but allow for some flexibility. Finally, new accounting concerns arise frequently as businesses and other organizations explore new activities and strategies. Most accounting rules are only created after long periods of careful analysis. However, even in those cases where rules do not yet exist, theoretical guidance is available to help organizations and officials come up with reasonable answers for proper reporting.

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(3) – What are these accounting rules called?

In the United States, financial accounting rules are referred to as U.S. Generally Accepted Accounting Principles (or, more likely, U.S. GAAP). The thousands of pages of U.S. GAAP that have been created over the decades are gathered together in an online volume known as the Accounting Standards Codification.

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(4) – Who is in charge of creating or modifying U.S. GAAP?

The Financial Accounting Standards Board (FASB) was created in 1973 and is still in charge of U.S. GAAP. A plethora of information about FASB can be discovered at www.fasb.org. One way to learn more about the development of U.S. GAAP is to click on “About Us” on this website and then on “Standard-Setting Process.”

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(5) – Is U.S. GAAP used throughout the business world even outside of the United States?

U.S. GAAP is used in the U.S. and a few other countries. Nevertheless, the basic rules for U.S. GAAP are understood in many areas of the world especially in countries with well developed economies. In most of the countries outside the U.S., International Financial Reporting Standards (IFRS) serve as the basic rules for financial reporting. Information about that set of rules can be found at www.ifrs.org.

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(6) – Who creates and modifies IFRS?

The International Accounting Standards Board (IASB) located in London is in charge of IFRS.

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(7) – In general, what is the difference in how U.S. GAAP was developed and how IFRS was developed?

U.S. GAAP has been created one rule at a time for 70-100 years. The rule-making process significantly escalated when FASB was created in 1973. In contrast, IFRS began as an accumulation of rules from different countries around the world. Initially, many optional rules were allowed. When the IASB was created in 2001, that board began to narrow those options and also to create other rules of its own.

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(8) – How similar is U.S. GAAP to IFRS?

In a great many areas, these two sets of rules are virtually the same. Nevertheless, in numerous key areas, there are differences (often significant in scope).

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(9) – In Chapter Two of the textbook, a quote is presented from a Wall Street Journal article, “When the intellectual achievements of the 20th century are tallied, GAAP should be on everyone’s Top 10 list.” That seems ridiculous. How could U.S. GAAP be so vital to our world?

No one can deny that the growth of the U.S. economy since World War II has been unprecedented. Businesses and other organizations from Florida to Alaska have prospered and furnished the country and the rest of the world with an enormous number of products and services as well as millions of jobs. Those entities could not get started and grow to such an enormous size without money from investors and lenders. The ability or organizations to raise capital is essential to our economy. Investors and lenders must (a) be willing to provide money and (b) make the best allocation of those financial resources so that the right organizations benefit and grow. The rules for U.S. GAAP provide the foundation for the clear communication of the financial information that goes to decision makers and aids them in making wise decisions on investing and lending.

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(10) – One of the most important things that an organization can report to decision makers is information about its assets. What is an asset?

An asset is a probable future economic benefit owned or controlled by the reporting entity.

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(11) – In describing an asset, the term “probable future economic benefit” is used. What does that term mean?

For the most part, a probable future economic benefit is anything that helps a company generate revenues. If you own or control any item that helps you create sales, that probably qualifies as an asset.

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(12) – What are examples of assets that an organization might report within its financial information?

These are not mysterious. They are fairly obvious. Walk into any business and you will see many assets. Assets include cash, inventory, equipment, patents, buildings, land, and the like. Financial accounting communicates information about assets such as these. That is important to decision makers.

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(13) – What is a liability?

Organizations must also report information about their liabilities. That term encompasses the debts of the organization. More formally, liabilities are probable future economic sacrifices.

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(14) – What does the term “net assets” mean?

Mathematically, the term “net assets” is simply an organization’s assets less its liabilities. The resulting figure serves as one measure of the size of the organization. One of the goals of most organizations is to increase net assets as a sign of growth and prosperity. Recently, The Coca-Cola Company reported assets of $87.3 billion and liabilities of $66.0 billion. At that point in time, the net assets for this massive company was $21.3 billion.

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(15) – A company reports earning revenue of $6.3 million during the past year. That is financial information. What is revenue?

Revenue is a measure of the inflow (or increase) in an organization’s net assets generated by the sale of goods and services. If a company reports revenues of $6.3 million, it is saying that it made sales during the period of that amount.

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(16) – A company reports expenses of $4.7 million during the past year. What does this statement indicate to a decision maker?

Expenses are a measure of the decrease or outflow of an organization’s net assets in its attempt to generate revenues.

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(17) – You start a business. You plan to hire friends and provide lawn care to your neighbors. What might be some of your expenses?

Even a small business could have a number of expenses such as salary expense, advertising expense, maintenance expense (such as gasoline and oil), and the like. They are decreases in net assets that were incurred in hopes of generating revenues.

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Financial accounting can be learned and it can be learned very well. It does take time and effort. If it were easy, everyone would be rich. You cannot just pretend to do the work. Nothing good comes from that approach. I am convinced that if you go through these questions and answers a few times you will know and understand them as well as any decision maker anywhere.

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