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CHAPTER I
THE ACCOUNTANCY PROFESSION
QUESTION 1-1

Define accountin g.

ANSWER 1-1

The Accounting Standards C.Ouncil defines accounting as follows:

Accounting is a service activity. Its function is to provide

quantitative information, primarily financial in nature, about
economic entities, that is intended t.o useful in making
economic decision.

The Committee on Accounting Terminology of the American

Institute of Certified Public Accountants defines accounting as
follows:

' Accounting is the art of recording, classifying_and

summarizing in· a significant manner and in terms of · ·
money, transactions and events which are in part at least
of a financial character and interpreting the results
thereo£

The American Accounting Association in its Statement of Basic

Accounting Theory defines accounting as follows:

Accounting is the process o( identifying, measuring and

communicating economic information to permit informed
judgment and decision by users of the information.

1
QUESTION 1-2
What is the overall objective of accounting?
ANS\VER 1-2
~e ov~ral_l objectiv~ of accounting is to provide quantita tive
financia l informutI~n abo ut n bus ine~s t ha t is useful to
stateme_nt us~r~ par ticularly owners and creditors in maki ng
econom ic dec1s10ns.
rhe pri~ a ry task of an accounta n t is to supp ly financial
~nforma tion so that the statenrnnt users could make informed
Judgment and better decision.
QUESTION 1-3
What do you understand by the account~ncy profession?
ANSWER 1-3
Republic Act _No. 9298 _i~ th_e law regulating the practice of
accountancy m the Ph1hppmes. This law is known as the
"Philippine Accountancy Act of 2004".
ACC?untancy has developed as a profession attaining a status
equivalent to that of law and medicine.
In the Philippines, in order to qualify to practice the
accountancy profession, a person must finish a degree in
Bachelor of Science in Accountancy and pass a very difficult
government examination given by the Board of Accountancy.
The Board of Accountancy is the body authorized by law to
promulgate rules and regulations affecting the practice of the
accountancy profession in the Philippines.
The Board of Accountancy is responsible for preparing and
grading the Philippine CPA examination.
This computer-based examination is offerf l twice a year, one
in May and another one in October in a uth ized testing cent.ere
around the country. · '
2
QUESTION 1-4
ExpJain the accreditation to practice public accountancy.
ANSWER 1-4
Ce rtifie d P ublic Acco untants , firms and partne rship of
ce r tifie d pu bli c accounta nts , including partne r s a n d -s taff
members the reof, are required to register with the Board of
Accounta ncy and Professional Regulation Commission for the
practice of public accountancy.
The PRC upon favorable recommendation of the Board of
Accountancy shall iss ue the Certificate of Registration to
practice public accountancy which shall be valid for 3 years
and renewable every 3 years upon payment of required fees.
Certified Public Accountants gen e rally practice their
profession in three main areas, namely:
a. Public accounting
b. Private accounting
c. Government accounting
QUESTION 1-5
Explain 't he limitation of the practice of public accountancy.
ANSWER 1-5
A certificate of accreditation shall be issued to certified
public accountants in public practice only upon showing in
accordance with rules and regulations promulgated by the
Board of Accountancy and approved by the Professional
Regulation Commission that such registrant has acquired a
minimum of three years of meaningful experience in any of
the areas of public practice including taxation.
Single practitioners and partne~ships for th_e _practice ~f
public accountancy shall be registered cert1f1ed public
accountants in the Philippines. .
The Securities and Exchange Commission shall not register
any corporation organized for the pract ice of public
accountancy.
3
 QUESTION 1-6
What is public accounting?
- QUESTION 1-8
ANSWER 1-6
Public accounting, in esse nce, 1s the proctice of the
accountancy profession.
Individual practitioners, small accounting fi r ms and large
multinational organizations render independe nt and expert
financial services _to the pu~lic such as auditing, taxation and
management advisory se1v1ces.
QUESTION 1-7
Explain the three kinds of services rendered by a public
accountant.
ANSWER 1-7
1. Auditing ha~ traditionally been the primary service offered
by most public accounting practitioners.
Aud_iting ~r specifically exter~l auditing is the examination
of financial statements by independent certified public
account,ant for the purpose of expressing an opinion as to the
fairness with which the financial statements are prepared.
Actually, external auditing is the attest function. of
independent CPAB.
The Bureau of Internal Revenue requires audited financial
statements to accompany the filing of annual income tax
return.
Banks and other lending institutions frequently require an
audit by an independent CPA before granting a loan to the
borrower.
2. Taxation service includes the preparation of annual
income tax returns and determination of tax consequences
of certain proposed bus iness endeavors.
The CPA not infrequently represents the client in tax
investigations.
3. Management advisory service has no precise coverage.
Generally, this area of practice refers to services to clients
-on matters of acC!oun~ing, financ e, business policies,
organization procedures, product costs, distribution ana
other phases of business conduct and operations.
4 5
Explain private acco unting.
ANSWER 1-8
Private ac counting me ans t hat Ce rtified Public
Accountants are employed in business e ntities in various
cap a city as acco unting s ta ff, chief accountant, internal
auditor a nd controller.
The highes t acco unting office r in a· business entity is the _
controller.
The m Ajor objP.ctive of the private accountant is to _assist
manage ment in planning and controlling the operations of
the en tity.
Private accounting includes mai~taining the records,
producing the financial reports, p.rcp~ring th: budgets and
controlling a nd allocating the costs of the business.
The private accountant has also the resp_onsib~ity ~or the
determina tion of the various taxes the business 1s obliged to
pay.
QUESTION 1-9
J
Explain government accountin g.
ANSWER 1-9
Government accounting encompasses the proooss of analyzing,
clas!lifying, summarizing a nd comm unicating all transactions
involving the receipt and disposition of government funds and
property and interpreting the results thereof.
The {ocu.s of gou ernm.ent acco unting is the custody and
administration of public fnnds.
Many Certified. Public Accou ntants a re employed in many
brnnches of :he gove--:nment, more par ticularly t he Bureau of
Internal H.evenw~, Corn mi:Jsion on Audit, Departme nt of Budget
and Management, Securities and Exchange Commission and
1_;ven in a police agency like the NMional Bureau ofinvestigation.

QUESTION 1-10
What do you understand by the Continuing Profess ional
Develop ,neut or CPD?
ANSWER 1-10
P.epublic Act No. 10912 is the law mandating and strengthening
the continuin g professional deve lopm t: n t program for all
regulated professions, including the accountancy profession .
All certified public accountants 1:;hall abide by the requiremen ts,
rules a nd regulations on continuing professional educa fam to
be promulgated by the Board of Accountancy, subject to the
approval of t he Professional Reg ulation Commission, in
coordin a tion with the accredited national professional
organization of ce r tified public accou n t an ts or any duly
accredited educational institution.
Continuing professional education is defined a s the inculcation
and acquisition of advanced knowledge, skill, proficiency, and
ethical and moral vnlucs afte r the initial registration of the
Certified Public Accountant.
' Accountants.
Continuing professional education raises a nd enhances t he
techni ca l skill and co mpetence of th e Certified Publi c
Accounta nt.
G 7
QUESTION 1-11
What is the meaning of CPD credit units?
AN~WER 1-11
The CPD credit units refer to the CPD credit hours required
for the renewal of CPA license and accreditation of a CPA to
practice the accountancy profession every three years .
Under the new BOA Resolution , all Certi(ied Public
Accountanls regardless of area or sector of practice shall be
required to comply with 120 CPD credit units in a compliance
period of three years.
However, the initial implementation of the 120 CPD credit units
is gradu al in the following period:
2017 80 credit units
2018 100 credit units
2019 120 credit units
Excess credit units earned shall not be carried over to the next
three-year period, except credit units earned for masteral and
doctoral degrees.
It is to be e mphasized that the Continuing Professional
Development has becom e mandatory for Certified Public
The Continu.ing Professional Development is requin~d for the
renewal of CPA license and uccreditation of CPA to practice the
accountancy profession.
QUESTION 1-12
Explain exemption from CPD requirem~nt.
ANSWER 1-12
A CPA shall be p ermanently exempted from CPD
requi re ments upon reaching the oge of 65 years.
I_Iowe vc r, this exemption applied only to_th~ renewal o~ CPA
license a nd not for the purpose of accreditation lo practice the
acco1Lntancy profession.
 QUESTION 1-13
Distinguish accounting and auditing.
ANSWER 1-13
[n a br oad s ense, accounting embraces auditing. Auditing is
one of the areas of accoun ting specialization.
In a limited sense, accounting is essentially constru.ctiue in
nature. Accou nting ceases when finan cia l stateme nts are
already prepared.
On the other hand, auditing is analytical. The work of an auditor
begi.ns when the work of the accountant ends.
QUESTION 1-U
Distinguish accountL,g and bookkeeping.
ANSWER 1-14
Bookkeeping is p rocedural and largely concern e d with
development and maintena nce of accounting records.
Bookkeeping is the "how" of accounting.
Accounting is conceptual and is concerned with the why, reason
or justification for any action adopted.
Bookkeeping is a procedural ele me nt of accoun t ing a s
:3-rithmetic is a proc~dural element of mathema tics.
QUESTION 1-15
Distinguish fina ncial accou nting and ma nage rial accounting.
ANSWER 1-15
Financial accoun ting focu ses on general purpose reports known
as financial statements which a re intended for internal a nd
extern.al users.
Finan?ial account0 r: is the nrea of accou nt ing that empha sizes
r(::portmg to crcd,ton; and inve stors.
Manal{erial accou n li1~g is the accu mulation and prepara tion of
financ1aJ reports for interrw l users only.
In other word~. mnnagcrial accounting is the area of accountin ~
th_a t ~mph nsiz.es de velop ing acco unting information for ust
wt thin an e ntity.
0 9
QUESTION 1- 16
Wl1at is the meaning of generally accepted accounting principles?
ANSWER l -16
Ge nerally a ccepted accounting pri nciples (GA.AP) e ncompass
the conventions, rules a nrl procedures necessa ry to define
wha t is accepted accounti,ng practice.
Gene ra lly accepted accoun ting principles are cvnventional.
ThP, pri nciples becom e ge nerally accepted by agreement often
tacit a greemen t rather t han by form al deriva tion from a set
of post ula tes a nd basic cuncepts.
The principles have deve loped on t he ba sis of e.x perience,
reason, custom, usage and practical necessity.
Generally accepied accounting principles represent the n des,
procedures, practice and standa rd s followed in the
preparation ar.,d presen!aticn of financial statements.
GeneraJly accepted accounting principles are like iaws that
must be followe d in financial reporting.
QUESTION 1-17
What do you understand b y the Financi a l Reporting
Standar ds Council or FRSC?
ANSWER 1-17
The FRSC is the accounting standard setting body created
by th e Professional R e gula t ion Commission upon
recomme ndation of the Board of Accountancy to assis t the
Board of Accou n ta ncy in carrying out its powers a nd functions
provided under R.A. Act No. 9298.
The main function is to establish and improve accounting
standards that will be: generally accepted in the Philippines.
The accounting standards promulgated by the Financial
Reporting Standards Council constitute the "highest
hierarchy" of g e nerally'accepted accounting principles
in the Philjppines.
The app r oved stateme nt s of the FRSC are known as
Philippine Accounting St andards or PAS and Philippine
Finaucia .l Reporting Standnrds or PFRS.
QUESTION 1-18 QUESTION l-20
\Vhat is t he composition of FRSC? Whnt do yo u understand by the In te rnational Accounting
Standards Committee (IASC)?
ANSWER 1-18
The FRSC is composed of 15 with a Chairman who had been ANSWER 1-20
or is presently a senior a ccounting practitioner a nd 14
representatives from t~e following: Th_e ~ C is a~ i!'ldepei:idenL private sector body, with the
obJ~ct1ve of achieving un~formity in the accounting principles
Board of Accountancy 1 which are used by bu s iness and other organizations for
Securities nnd ExchangP Commission 1 financial repor ting around the world.
Bangko Sentral ng Pilipinas 1
Bureau oflnternal Revenue l lt was ~ormed in June 1973 th~ough an agreement made by
Commission on Audit 1 professio nal aecoun ta ncy bodies from Australia, Canada,
Major organization of preparers and users of
financial stat.ementa- Financial Executives Institute France, Germany, Japan, Mexico, the Netherlands, the United
of the Philippines or FINEX 1 Kingdom and Ireland, and the United States of America.
ACCT€ciitecl naiiona.l professional or~anization of CPAs: The approved st atem ents of the IASC are known a s
Public Practice 2 Interna tiona l Accounting Standards or IAS.
Commerce and Industry 2
Academe or Education 2
Government 2 QUESTION 1-i1
Total 14 What do you u i1derstand· by the Jnternational Accounting
Standards Board?
The Chairman and mem bcr-s of the F'RSC shall have a term
of 3 years renewable for a nother term. ANSWER 1-21
The Internation al Accounting Stand a rds Board or IASB now
replaces the International Accounting Standards Committee
QUESTION 1-19 or IASC.
What do you unders t and by th e Philippine Interpretations The IASB publishes standards in a serie~ of pronouncements
Committee? · called "International Financi al Reporting Standards" or
IFRS .
ANSWER 1-19
Howe ve r, the IASB has adopted the body of standards issued
The Philippine Inte r pretations Com mi ttee or PIC was form ed by the IASC.
for the following role:
The pronouncements of the IASC continue to be designated
a. To prepare in terpretat ions of PFRS for approval by the as "International Accounting Standards" or IAS.
FRSC.
The lFRS is a global phenomenon intended to bring about
b. To provide timely guidance on fi nancial rP.porting issues ~reater transparency and o higher degree of comparability
not specifically addressed in curr~nt PFRS . m financial re porting.
Th~ interpre_talions or e intend ed t o give a.u thoritatiue Such phenomenon is essential to achieve the goal of one
guidance on issues that a re hkcly to receive d1verge nt or uniform and globally accepted financial reporting
unacceptable tre a tment beca us e the sta ndards do not standards.
provide specific a nd clearcu t m ies an d guid elines.
11
10
 QUESTION 1-22
What do you understand by the "P hilip pin e Fi nancial
Reporting Sta ndards"?
ANS\VER 1-22
The Financial Reporting Standards Council issues standards
in a series of pronouncem·ents called "Philippine Financial
Reporting Standards" or PFRS .
The Philippine Financial Rep0r t ing Standards collectively
include all of the following:
a. Philippi n e Financial Reporting Standards which
correspond to J nternati:rnal Financial Reporting
Standards.
The Philippine Finartcial Reporting Standards at·e
numbered the same as their counterpart in Intematioinal
Financial Reporting Standards.
b. Philippine Accounting Standards which correspond to
International Accounting Standards.
The Philippine Accountinr Stmirlards are numbered the
same as their cou nterpa rt in Internat ional Accounting
Standards.
c. Philipp i ne Interpreta t io n s which correspond to
Interpretations of th e I F RIC and the Stan d in g
Interprfr.tati on s Committee , and Interpretations
developed by the .Phil ippine Interpreta tions Com mittee.
12
QUESTION 1-23 Multiple choice (ACP)
1. What is the law regulating the practice of ac-countancy in
the Philippines?
a. R.A . No. 9298
b. R.A. No. 9198
c. R.A. No. 9928
d. R.A. No. 9892
2. It is the body authorized by law to promulgate rules and
regulations affecting the practice of the accountancy
profession in the Philippines.
a. Board of Accountancy
L. Philippine Institute of Certified Public Accountants
c. Securities and Exchange Commission
d. Financial Reporting Standards Council
3. The qualifications of the members of the Board of
Accountancy include all of the following, except
a. Must be a natural-born citizen and a resident of the
Philippines.
b. Must be duly registered CPA with at least ten years of
work experience in any scope of practice of accountancy.
c. Must be of good moral character and must not have
been convicted of crime involving moral turpitude.
d. Must have any pecuniary interest, directly or
i~directly, in any school conferring an academic degree
necessary for admission to the practice of accountancy.
4. What are the three main areas in the practice of the
ac<;ountancy profession?
a. Public accounting, private accounting and managerial
accounting
b. Auditing, taxation and managerial accounting
c. Financial accounting, managerial accounting and
corporate accounting
d. Public accounting, private accounting and government
accounting
13
 • t he pr1mar
s. Wh at 1s · y service of CPAa in public practice?
9. Which sta tement is true regarding exemptions from CPD
a. Auditing require ments?
b. Taxation .
c. Managerial accountmg a. A CPA shall be permanently exemp ted from CPD
d. Controllership requiremen·t for renewal of CPA license at the age of
66 yea rs but not for the accreditation to practice the
6 _ Accountants employed in entities in various capaci~ as accountancy profession .
accounting staff; chief accountant or controller are srud to b. A CPA who is working or practicing the professioDn
be engaged in abroad shall be temporarily exempted from CP
requirement during the period of stay abroad
a. Public accounting provided the CPA has been out of the country for at
b. Private accounting least two years prior to the date of renewal.
c. Government accounting c. A CPA who is furthering studies abroad shall be
d. Financial accounting temporarily exempted from CPD requirement during
the period of stay abroad provided the CPA has been
7. It is the area of the accountancy profession that out of the country for at least two years prior to date of
encompasses the process of analyzing, classifying, renewal.
summarizing and communicating all transactions d. All of the statements are true.
involving the receipt and disposition of government funds
and property and interpreting the results thereof. 10. Which statement is incorrect in relation to the practice
of public accounting?
a. Internal auditing a. Single practitioners for the practice of public accounting
b. External auditing shall be registered CPAs in the Philippines: .
c. Private accounting b. Partners of partnership formed for the practice of public
d. Government accounting accounting shall be registered CPAs ~e Philipp~nes.
c. The Securities and Exchange Comm1ss1on can register
8. The Continuing Professional Development is required any corporation organized for the practice of public
accounting.
for
d. The Professional Regulation Commission upon
favorable recommendation of the Board of
a. Renewal of CPA license Accountancy shall issue certificate of accreditation to
b. Accreditation to practice the accountancy profession. CPAs in public practice provided the registra~t has
c. Both · renewal of CPA license and accreditation to acquired a minimum of three years of meaningful
practice the accountancy profession. experience in public practice. .
d. Neither renewal of CPA license nor accreditation to ANSWER 1-23
practice the accountancy profession.
1. a 6. b
2. a 7. d
3. d 8. C
4. d 9. d
5. a 10. C

14 15
 QUESTION 1-24 Multiple c h oice (ACP)
1. Which is the accountin g stR_!1dn~d setting body in the
Philippines at the present tame.
Accounting Standa rd f.l Council
f ~h/l:~i;i~:'tcc~~.~~i~r St~~d':.~d~dB~~dncil
d. Financial Reporting ta nda rds Council
2. Which statement is true regarding the FRSC?
a. The FRSC is crea ted by Professional Regulation
Commission upon recommendation of the Boord of
Accountancy in carrying out its powers a nd functions
under R.A. 9298.
b. The FRSC shaU be composed of 15 with a Chairman
and 14 representatives.
c. The Chairman and members of FRSC are appointed
by Professional Regulation Commission upon
recommendation of the Board of Accountancy and
shall have a term of three years renewable for another
term.
d. All of the statements are true. •
3. All of the following are represented in FRSC, except
a. Board of Accoun·tancy
b. Securities and Exchange Commission
c. Comission on Audit .
d. Department of Budget and Management
4. The Philippine Financial Reporting Standards
collectively include
a. PFRS correAponding to IFRS.
b. PAS corredponding to lAS
c. Philippine Interpretations corresponding to IF~RIC
and SIC Interpretations and Interpretations
developed by PI C.
d. All of these are included in Philippine Financial
Reporting Standards.
ANSWER 1-24
1. d 3. d
2. d 4. d
16
QUESTION 1-26 Mu ltiple choice (IFRS)
J. The International Arcou nting Standards Board was formed
a. To enforce ffHS in foreign countries
b. To develop a single set of high qua lity IFRS . .
c. To cAtablis h accounting sta ndards for m ultma t1ona 1
entities
d. To develop accounting sta ndards fo,· countr ies that do
not have their own standard-setting bodies
2. The IASB declared tha t the merits of propm;ed standards
are assessed
a. From a position of ne: utrality
b. From 1l position of mate riality
c. Based on possible impact on behavior
d. Based on arguments of lobhyii:;t
3. What is the chronological order in th e evaluation of a
typical standard?
a. Exposure draft, Standard and Discussion paper
b. Exposure draft, Discussion paper and Standard
c. Standard, Discussion i;>aper and E xposure draft
d. Discussion paper, Exposure draft and Standard
4. The IASB publishes standards called
a. International Accounting Standards
b. Financia l Reporting Standards
c. Internation al Financial Reporti ng Standa rds
d. Statement of Financial Acc·o unting Standards
5. The IASB employs a "due process" syste m which
a. Is an e ffici e n t sys t e m for collecting du e s from
members.
b. Enables interested parties to express their views on
issues under consHcration.
c. Identifies the most importa nt accountin g iss ues.
d. Requires t hat all CPAs must receive a copy of IFRS .
17
 6. What is "due process" in the standard- setting by lASB?
QUESTION 1-26 Multiple choice (IAA)
a. IASB operates in full view of the public.
b. Public hearings are held on pro~ose_d sta~da rds. 1. Fina ncial ~t:counting can be broadly defi ned as the area
of Recounting t hat prepares
c. Interested parties can make the1~ views known .
d. All of these are part of due process m sta ndard-setting. a. Gen~ral_ purpose fi nancial statements to be .used by
p~rtles_internal to the entity.
7. What is a possible danger if polit ics plays too big a role in b. Fma nc1al statements to be used by investors.
developing IFRS? c. Genera l purpose financial statements to be uoed by
parties both intern 9.l and external to the entity.
d. Fin an ci a l s tateme nts t o be used pr imarily by
a. Accounting standards are not truly generally accepted. management.
b. Individuals may influence the sta ndards.
c. User groups become active. · 2. Financial accounting emphasizes rep orting to
d. The IASB delegates its authority to elected officials. a. Management
b. Regulatory bodies
8. Financial accounting standard-setting c. Internal auditors
d. Creditors and investors
a. Can be described as a social proce.s s which reflects 3. Managerial accounting emphasizes
political actions of various interested user groups as
well as a product of r,esearch and logic. a. Reporting financial information to external users
b. Is based solely on research and empirical findings. b. Reporting to the Securities and Exchange Commission
c. Is a legalistic process. c. Combining accounting with data processing
d. Developing accounting information for use within an
d. Is democratic in the sense that a majority of entity
accountants must agree with a standard.
4. Which statement is true regarding managerial accounting
9. JFRIC Interpretations i~sued by IASB and financial accounting?
a. Managerial accounting is generally more precise.
a. Are considered authoritative and must be followed. b. Managerial accounting ~ee~ not foll? w g_enera_lly
b. Cover newly identified financial reporting issues not accepted accounting principles while financial
specifically addressed . accounting must follow GAAP.
c. Cove r issues with conflicting interpretations. c. Managerial accounting ha~ a fu ture f?cus_.
d. All of these a re true about IFRIC Interpretations. d. The emphasis on manager~al accoun~mg_ 1s _releyance
and the emphasis on financial accounting 1s timeliness.
ANSWER 1-25
ANSWER 1-26
1. b 6. d 1. C
2. a 7. a
3. d 2. d
8. a
4. C 9. d 3. d
6. b 4. . b

18 19
 QUESTION 1-27 Multiple choice (IAA)
1. Generally accepted a tXounti ng principles
·a. Are a ccoun tin g principles bas~d on la""·.
b. Derive their c:cdibility and a uth?rity f.ro mhlaw.
c. Derive thE:ir authority from ?""egu•atory &.ut ority.
d. Derive their credibility and a uthoi ity ..rom recognir: 00
a nd acceptance by the ac.coa ntancy ~rvfebSion.

2. Whi ch s t a te ment be ~t d':scr ibes g~n~rall y accepted

accounting princi ple~?
a The accountin g princip les have beer. formu la!.ed in
the public sector.
b. The accounting pri~~iples h ave been developed on the
basis of such fact~rs as usag~ a nd practical necessity.
c. The accounting principles are the same as laws .
d. · The accounting principles do not apply to SM.Es.

· 3. Proper applica tion of accoun ti ng principles is most

dependent upon
a. Existence of specific guidelines
b. Oversight of regulatory bodies
c. External audit function
d. Professional judgment of the accountant

4. Once an accounting standard has been established

a.. The standard is continually reviewed to see if
modification is necessary.
b. The standard is not reviewed.
c. The t ask of reviewing the standard is given to a
national organization of CPAs.
d. No revisions should be made to the standard.
ANSWER 1-27

1. d
2. b
3. d
4. a

20
CHAPTER2
CONCEPTUAL FRA1lfEWORK
Assumptions a,id financial reporting
QUESTION 2-1
What are accounting assumptions?

ANSWER 2-1
Ac~oun~ing assumptions or accounting postulates are the
basic notions or fundamental premises on which the accounting
process is based.
Acc~unting .assumptions are the "givens" which exist without
saying.
Like a building struct}.ll"e that requires a solid foundation to
avoid or preven~ future collapse and provide room for expansion,
and so with accounting.
Accounting assumptions serve as the foundation or bedrock of
a<XX>unting in order to avoid misunderstanding but rather enhance
the understanding and usefulness of the financial statement..'3.

QUESTION 2-2
What are the underlying accounting assumptions?.

ANSWER 2-2
a. Going concern
b. Accounting entity
c. Time period
d. Monetary unit
The Conceptual Framework for Financial Reporting mentions
only one assumption, namely going concern.
However. implicit in accounting_are the basic assum~tions
of accounting entity, time period and monetary unit.

21
QUESTION 2-3
F.xplain the going concern ass umption.
ANSWE R 2-3
Goin 1; concern assumption means that the accounting
,? nti tv i~ viewe d as continuing in opera tion indefinitely in
the abse nce of evidence to the contrary.
Going concern assumption is a lso k now n as t he continuity
assumption.
In other words, fi na nci al sta te ments are prepared normally
on the assumption that the entity shall continue in ope ra tion
for the foreseeable future .
Thus, assets are normally recorde d at original acquisition
cost. As a rule, market values are ignored.
How~ver , some new standards require measureme~t of
certam assets at fair value.
This postulate is the very foundation of the cost principle.
QUESTION 2-4
Explain the accounting entity assumption.
ANSWER 2-4
In fi_n ancial a<:cou n_ting, the accounting enti ty is the specific
bu siness _ent erpn se, whi ch ma y be a proprietorship,
partnerslup or corporation .
Under this assumption, the entit,y is separate from the owners,
managers, and employees who constitu te the entity .
According_l y, th e transaction s of the entity should not be
merged with the trnnoaclions cf the owners.
Th e _personal tramlactions of the owners ahouid not be allowed
to distort th: fina ncial statements of the enti ty.
~he re~50n for th.is RPsumptio11 ia to have a fuir p resentation of
/t na rvw l stutem ent.9.
22
QUESTION 2-5
Explain the lime p eriod assumption .
ANSWER 2-5
The time period a ssumption requ ires that ''the indefinite
Jjfc o( an entity is subdivided in to time pe riods or accounting
periods which are usu a lly of equal length for the purpose of
p reparing financial reports on fin ancial position, financial
perfor mance and cash flows".
By co11vcntion, the accounting period or fisc al periorl is one
year or a period of twelve months.
The "one-year period'' is traditionally the accounting period
beca use usually it is after one year th at government reports
are requ ired.
The accounting period may be _a calendar year or a _natural
business year. A calendar year 1s a twelve-month period that
ends on December 31.
A nat ura l business year is a twelve-month period that ends
on any mo nth when the business is at the lowest or
experiencing slack season.
QUESTION 2-6
Explain the monetary unit .ass:.imption.
ANSWER 2-6
Th e monetary un it assui:rption has two aspects, namely
quantifla bility and s tability of the peso.
The quantifiability aspect means that the asse~s. liabilities,
equ ity, income and expenses shoul~ be stat~d. m _terms of a
unit of me asure which is the peso m the Philippines.
The stab ility of t he peso n~sumption means thai the
purchasing power of the peso 1s s table or constant ~n t at
its instahili tv is insignificant and therefore may be ignored.
Th e stable p~so post.uiate is actua lly a n arnpli~cation of the
· concern
going · · so muc•h so
ass umption . that adJustmenta
in ower are ·
unnecessary to reflect any changes in purchas g P ·
The accounting functio~ is to account for pesos only D nd not
/or changes in p nrchasing power.
23
 Q UESTION 2-7
QUESTION 2-8
Wh at do you u nders tand by Conce p tua l Frn mework for
Financial Repor tin g'? What are the basic purposes of the Conceptual Framework?

ANS\i\'FR 2-7 ANSWER 2-8

The Cc nceptual Framewc>rk for Financinl Reportin g is a a. T o assist th e Financial Reporting Standards Council int
complete, comprehe nsive and s in gle document promulgated developing accoun ting standards that represen
by the Interna tional Accounting Sta nd a rd s Board . Philipp ine GAAP.

The Concep tual Frame work is a s umm ary of th e terms and b. To assis t preparers of financial statemehn~s in appltyingt
concep ts t hat underliP. the prepa ration and presentfl tion of accounting s tandards and in dealing wit issues no ye
financial statements. covered hy GAAP.

It is the underlying theory for the development of accounting c. To assist the Financial Reporting Standards Counci~ in
standards and revision of previously issued accounting its review and adoption of International Accountrng
s tandards. Standards.

The Conceptual Fran1eworll is an attempt to provide an overall d. To assist users of financial statements in interpreting the
theoretical foundation for accounting which will guide standard information contained in the financial statements.
setters, preparers and users of financial mformation in the
preparation and presentation of statements. e. To assist auditors in forming an opinion as to whether
financial statements conform with Philippine GAAP.
The concepts serve as the found a tion on which financial
statements are constructed and provi<le a pla tform fr.om which f. To provide information to those interested in work
accounting standards are developed and revised. of the Financial Reporting S t andards Council m the
formulation of Philippine Financial Reporting Standards.
The Concept ua l Frameworli is concerned with general
pu r pose financial state ments, including consolidated
fin a ncial statements. ·

Th e financial statements a re prepared at least annually and

a re directed toward the conunon nee ds of a wide ra nge of
u se 1·s.

Howeve r, s pecial purpose financial reports, for exa mple,

pros pectu s es and compu tat ion :, prepared for taxa ti on
purpo s e s , ar e ou t sid e th e s cope of th e Concept ual
Frumeworlt.

24 25
QUESTION 2-9
Exp la in t h e nuthoritativc status of the Conceptual
Framework.
ANSWER 2-9
If there is a standard or an interpretation that
specifically applies to a transaction, the standard or
interpretation overrides the Concep tual Framework
In the absence of a standard or an interpretation that
specifically applies to a tranRa<:tion, manage ment shall
consider the applicability of lh e Conceptual Framework in
developing and applying an accounting policy that results in
information that is relevant and reliable .
However, it is to be stated that the Conceptual Framework
is not a Philippine Financial Reporting Standard and
hence does not define standard for any particular
measu rement or disclosure issue.
Nothing in the Conceptual Framework overrides any specific
Philippine Financial Reporting Standard.
In case where there is a conflict, the ?"equirements of the
Philippine Financial Reporting Standards shall prevail over
the Conceptual Fram eworll.
QUESTION 2-10
What is the scope of the Conceptual Framework?
ANSWER 2-10
a. Objective of financial reporting
b. Qualitative characteristics that determine the usefulne !:\S
of useful financial information
c. Definition, recognition and measurement, of the elements
from which financial statements are constructed
d . Concepts of capital and capital maintenance
26
QUESTION 2-1 1
Explain financia l reporting.
ANSWER 2-11
Financial reporting is the prov1s10n of financial
information about an entity to external users that is useful
to them in making economic decisions a nd for assesssing the
effectiveness of the entity's nurnagement.
The principal way of providing financial information to
. exte rn al U6ers is t hrough the annual financial statements.
However, fi no nt ial reporting e ncompasses not only financial
statements but. ab,o other means of communicating
inform a tion that relates directly or indirectly to the financial
accoun ting process.
Financial reports include not only financial statemen ts but
also other information such as financial highlights, summary
of important financial figures, analysis offinv.ncial statements
and significant rat,ios.
f 'inancial reports also include nonfinancial information such
as description of major products and a listing of corporate
officers and directors.
The overall objective of financial reporting is to provide
financial information that is useful to existing and potential
investors, lenders and other creditors in making decisions abou/.
providing resources to an entity.
QUESTION 2-12
Enumerate the ''specific objectives" of financial reporting.
ANSWER 2-12
a. 'To provide information useful in making decisions about
providing resources to the entity. ·
b. To provide information useful in assessing t.he prospel'.1 .-
of future net cash flows to the entity.
c. To provide information about entity resources, claims :rnJ
changes in resources and claims.
~,
 Q UESTION 2-13
QUESTION 2-14 Multiple choice (IAA)
What are the lim itations of fin a ncial repor ting?
1. Wh at is the only underlying assumption mentioned in
ANSWER 2-13 the Conceptual Framework for Financial Reporting?
a. General pu rpose financia l re ports do not and cannot a. Going concern
provide all of the information that existing and potential b. Accounting entity
investors, lenders and other creditors need. c. Time period
d. Monetary unit
b. General purpose financial reports are not designed to show
the value of an entity but tliE:! se reports provide information 2. Which statement best describes the term "going concern"?
to help the p rimary users estiniate the vaht.e of the entity.
a. When current liabilities of an entity exceed current
c. General purpose financial reports are intended to provide assets
common information to users and cannot accommodate every b. The ability of the entity to continue in operation for
request for infor mation. the foreseeable future
c. The potentia l to contribute to the flow of cash and
d. To a large ext e n t , general purpose financial reports are cash equivalents to the entity
based on estimate and judgment rather than exact depiction. d. The expenses exceed income

3. Which of the following is not an implication of the going

concern assumption?

a. The historical cost principle is credible

b. Depreciation and amortization policies are justifiable
and appropriate.
c. The current and noncurrent classification of assets
and liabilities is jus.tifiable and significant.
d. Amortizing research and development costs over
several periods is justifiable and appropriate.

4. The relatively stable economic, political and social

environment supports

a. Conservatism
b. Materiality
c. Timeliness
d. Going concern

28 29
 Q UESTION 2-13
Q UESTION 2-14 Multiple choice (lAA)
\\''hat are the lim itations of fi nancial reporting?
1. Wlrnt is t he only und e rlying a ssumption mentioned in
ANSWER 2-13 the Concept ua l F ramework for Financial Reporting'!

8_ General purpose finan cia l repor ts do not a nd cannot a. Going concern

provide all of the info rm atiot'l t hat existing a nd potential b. Accoun ting en tity
investors, lenders a nd other creditors need. c. Time period
d. Monetary unit
b. General purpose fina ncial reports are not designed to show
the value of an entity but tliese reports provide inforrnatum 2. Which s tatement best describes the term "going concern"?
to help the prima ry users estiniale th~ ualu.e of the entity.
a. When current liabilities of an entity exceed curren t
c. General p urpose financial reports are intended to provide assets
common i11.form.aticn to users and cannot accommodate every b. The abili ty of the entity to conti nue in operation for
request for infor mation. the fore seeable future
c. The potential to contribute to the flow of cash and
d. To a large ext ent, general purpose financial reports are cash equivalents to the entity
based on estim ate and judgment rather than exact depiction. d. The expenses exceed income

3. Which of the following is not an implication of the going

concern assumption?

a. The historical cost principle is credible

b. Depreciation and amortization policies are justifiable
and appropriate.
c. The current and noncurrent classification of assets
and liabilities is jus.tifiable and significant.
d. Amortizing research and development costs over
several periods is justifiable and appropriate.

4. The relatively stable economic, political and social

environment supports

a. Conservatism
b. Materiality
c. Timeliness
d. Going concern

28 29
5. Which basic assumption may not be followed when an f
10. Which is not an important characteristic of the nancial
en tity in bankruptcy reports financi a l res ults? statements that' accountants currently prepare .

a. Economic entity assumption a. The information in financial statements is expressed in

b. Going concern assump t ion units of money adjusted for changing purchasing power.
c. Time period assumption b. Financial statements articulate with one anotdher
d. Monetary unit assumption because measuring financial position is relate to
measuring changes in financial position.
6. The financial statements of the business entity are c. The information in financial statements is summarired
separate and distinct from the financial statements of the and classified to help meet users' needs. .
owners. d. Financial statements can be justified only if the
benefits exceed the costs.
a. Going concern assumption
b. Matching principle ANSWER 2-14
c. Economic entity assumption
d. Accounting period assumption 1. a 6. C
2. b 7. d
7. The f'conomic entity assumption 3. d 8. C
4. d 9. a
a. . Is inapplicable to unincorporated businesses 6. b 10. a
b. Recognizes the legal aspects of business organizations
c. Requires periodic income measurement
d. Is applicable to all forms of business organizations

8. Which underlying assumption serves as the basis for

preparing financial statements at regular arbitrary or
artificial points in time? ·

a. Accounting entity
b. Going concern
c. Accounting period
d. Stable monetary unit

9. ~ich basic accounting assumptior. is threatened by the

existence of severe inflation in an economy?

a. Monetary unit assumption

h. Periodicity assumption
c. Going concern assumption
d. Economic entity assumption

31
30
 QUESTION 2-15 Multiple choice (AICPA Adapted)
QUESTION 2-1 6 Multiple choice (IFRS)
1. The concept of accounting entity is applicable
J. Wh at is th e aut ho r itative stat us uf th e Conce ptual
a. Only to the legal aspects of business organizations Fram e work ?
b. Only to the economic aspects of b_usiness organizations 'Phc Conce ptua l F ram ework ha A the hi ~hest level of
l.l.
c. Only to business organizations auth ority.
d. Whenever accounting is involved b. Jn the a bsence of a s tnnda r<l or an inte,h·p re~ ation that
specifically a pplies to a tra nsaction, t c ,.,or..:eptua 1
2. When a parent and subsidiary relationship exists, consolidat.ed Fra me work s hall be followed.
financial statements are prepared in reoognition of In the abse nce of a standard or a n interpretation that
c. specifically applies to a transaction, management shall
conside r th e appl icability of th e <::on cept~tal
a. Legal entity Framework in developing and applying an accounting
b. Economic entity policy that results in information that is relevant and
c. Stable monetary unit reliable.
d. Time period -d. The Conceptual Framework applies only when the
International Accounting Sta.1dard Boa rd develops
3. The valuation of a promise to receive cash in the future new or revised s tandards:
at present value is valid because of the accounting
concept of 2. Which statement is true concerning t he Conceptual
Framework for Financial Reporting?
a. Entity a. The Conceptual Framework is not a reporting
b. Time period standard and does no t define standard for any
c. Going concern particular measurement or disclosure issue.
d. Monetary unit b. The Conceptual Framework is concrned with general
purpose financial statements including consolidated
financial statements.
4. What is the accounting concept that justifies the usage of
c. Nothing in the Conceptual Framework overrides any
accruals and deferrals? specific Philippine Financial Reporting Standard.
a. Going concern d. All of these statements are true about the Conceptual
Framework.
b. Materiality
c. Consistency 3. The Conceptual Fram e work deals with all of th e
d. Stable monetary unit following, except
a. The objective of financial reporting
ANSWER 2-16 b. The qualitative characteristics of useful financial
information
l. d c. The definition, recognition and measurement of the
2. b elements of financial statements
3. C d. Supplementary information
4. a
33
32
4. The Conceptu al Framework is intended to esta blish
a . Generally acce pted acco un ting principles .
b. The meaning of "prese nt fairly in accordance with
GAAP"
c. The objectives an <l con cepts fo r use i n developing
standards of financial accounting a nd reporting.
d . The hierarchy of sources of GAAP.
QUESTION 2.:.17 Multiple choice (IAA)
In t hP Con ce ptua l Framework for rinancial Reporting,
1. what provides the "why" of acco untin g?
a. Meas urement and recognitirm conce~t . .
b. Qualitative cha racteriRtic of accounting 111formatwn
c. Ele ment of financial statement
d. Objective of fina ncial reporting

5. The Conceptual Framework should 2. The underlying theme of the Concept ual Framework is
a. Decision usefulness
a . Lead to uni forri1i ty of fir,ancial statements among b. Understandability
entities within the same industry. c. Timeliness
b. Eliminate alternative a ccounting pri nciples. d. Comparability
c. Guide multinational entities in developing generally 3. 'Which is an important characteristic of the Conceptual
accepted auditing standards. Framework?
d . Define the basic objectives, terms and concepts of
a. To enable the accountancy profession tb solve more
accounting. quickly emerging practical problen:is .
b. To provide a foundation from which to build more
6. 'Which is not a purpose of the Conceptual Framework? useful financial accoun ting standa rds
c. To enhance comparability of financi a l statements
a. To provide definitions of key terms and concepts across entities
b. To provide specific guidelines for resolving situations d. All of these are important characteristics of the
not covered by existing accounting standards Conceptual Framework
c. To assist accountants in selecting among alternative 4. Which statement is not true concerning the Conceptual
accounting and reporting methods Framework?
d . To assist IASB in the standard-setting process
a. The Conceptual Framework should be a basis for
ANSWER 2-16 standard setting.
b. The Conceptual Framework should allow practical
problems to be solved more quickly.
l. C c. The Conceptual Framework should be based on
2. d fundamental trnth derived from the law of nature.
3. d d. The Conceptual Framework should increase users'
4. C understanding and confidence in financi a l reporting.
5. d ANSWER 2-17
6. b
I. d
2. a
3. d
4. C

34 35
 QUESTION 2-18 Multiple c hoice (IAA) 5. An objective of financial reporting is to provide

1. The prim ary fo cus of financial repor t in g ha s b , Information about the investors in the entity.
meeting the needs of wh ich of the follow ing ,•rou ee~ on ~: In fo tm ation about the liquidation value of the
' ps .
resource::: held by the entity. .
a. Ma1rngcmei:t c. nformation tha_ t is us efu l in as sessing cash flow
J
b. Exist ing a nd potenti al investors lenders und other prospects.
creditors ' d. Information tha t will attract new investors.
c. National and local ta xing au thorilics
d. Independen t CPAs 6. "Assessing cash flow prospects'' as an objective of financial
reporting 1s interpreted to mean
2. The overall object ive of financi al reporting is to provide
information a. Cash basis accounting is preferred over accrual basis
accounting.
a. That is useful for decision making b. Information about the fin a ncial effects of cash receipts
b. About assets,_ liabilities and owners' equity and cash payments is generally considered the best
c. About financial performance durina a period indicator of present and continuing ability to generate
d. That allows owners to asse:s management favorable cash flows.
performance · c. Over the long run, trends in revenue and expenses
are ge nerally more me a ningful than trends in cash
3. Which is an objective of financial reporting? receipts and disbursements.
d. lJl of the choices a re correct rega rding "assessing cash
a. To provide infor mation that is useful to those making flow prospects".
investing and credit decisions.
b. To provide information that is useful to management. ANSVlER 2-18
c. To provide information about prospective investors.
d. To provide information about ways to solve internal 1. b
and external conflicts about the entity. 2. a
3. a
4-. C
4. Which is an objective of financial reporting?
5. C
a. To provide information that is useful to management 6. C
in making decisions.
b. To provide info r mation that clearly portrays
nonfinancial transactions.
c. 'l'o provide information that is useful to assess the
&mount, timing, and uncertainty of prospective ca 3 h
receipts .
d . To provide information thut excludes claims again st
the resources.
37
36
QU ESTION 2-19 Mult iple choice (AICPA Adapted)
1. The objectives of financial reporting a re based on
n. T li e need for conse rvatism
b. Re porting on m anage mt:! nt stewardship
c. Generally accepted accounting principles
d. The needs of the use rs of the information
2. Financial reporting pet"tains to
a. f ndividua l business entities, rather than to industries
or an economy as a whole or to members of societ as
consum e r s Y
b. Individual business entities and an economy as a who!
or to members of society as consumers e
c. Individual business entities and an economy as a
whole, rather than to industries or to members of
society as consumers
d . Individual business entities, industries and an
economy as a whole, rather than to members of society
as consumers
3. During a period when an entity is under the direction of
a particular management, financial reporting will directly
provide information about
a. Both entity performance and management
performance
b. Management per formance but not entity performance
c. Entity performance but not mana gement performance
d. Neither entity performance nor manageme nt
perform a nce .
38
4. Which of the following is not listed as an objective of
financial reporting?
a. Fina ncial reporting shall provide information about
entity resources, claims agains t those resources and
changes in them.
b. Financial reportin~ shall provide infqrmation useful
in evaluating management stewardship.
c. Financial reporting shall provide information useful
i.n inves tment, credit and similar decisions.
d. Financial reporting shall provide information useful
in assessing cash flow prospects.
5. \\.'hich is -not an objective of financial reporting?
a. To provide information about assets and claims
against those as sets
b. To provide information that is useful in assessing
sources and uses of cash
c. To provide information that is useful in lending and
investing decisions
d. To provide information a bout liquidation value of an
entity
ANSWER 2-19
l. d
2. a
3. C
4. b
5. d
39

CH_APTER3
CONCEPTUAL FilAMEWORl(
Qualitative characteristics
QUESTION 3--1
Define qualitative characteristics of fina ncial state ments.
ANSWER 3-1
Qualitative characteristics are the qualities or attributes that
make financial accounting information useful to the users.
In deciding which information should be included in financial
statements, the objective is to ensure that the
information is useful to the users in making economic
decisions,
Qualitative characteristics are class ified into:
a. Fundamental qualitative characteristics
b_ Enhancing qualitative characteristics
QUESTION 3-2
Explain fundamental qualitative characteriRtics.
ANSWER 3-2
The fundamental qualitative characteristics relate to the
content or substance of financial information.
The fundamental qualitative d 1aracteristics are relevance
and faithful re presentation.
Information must be Loth relevant and faithfully repre sented
if it i3 to be Ulieful. · an investment.
40
QUESTION 3-8
Exp lnin enhancing qualitative characteristics.
ANSWER 3-3
The enhanci ng qualitative chnracte ris tics are intended to
inc1·ease the usPfnlness of th~ fin a ncial information that is
relevant and faithfull y represe nted
T}1e en hancing qualitativl) ch a ri:i cterist ics rela t e to the
presentation or form of fina nci al information.
The enh a ncing qualita tive characteristics are:
a. Understandability
b. Comparability
c. Verifiability
d . Timeliness
QUESTION 3-4
Explain the qualitative characteristic of relevance.
A...~SWER 3.-4
Relevance means "t he eapacity of information to inake a
difference in a decision made by users."
Relevance is the caµacit y of the information to influence
a decision.
Relevance reqnires that the financial information should be
related or pertinent. to the economic decision .
Information. that does not bear on an economic decision is useles:;.
To be useful, the information must be relevant to the decision
making needs of users.
Broadly, the statement of financial position is relevant in
determining financial position and the income statement is
relevant in determining financial performance.
Specifically, the earnings per 1:1hare information i.s more relevant
than book value per share in determining the attractiveness of
41
QUESTlON 3-5
Explain the major ingredients of releva nt information
ANSWER 8-5
The ingredie nts of r eleva nce are p redi r. tive value an d
confirmatory value .
Information has predicti ue ualue when it ca n h e lp use rs
increase the likelihood of correctly predicting or forecasti ng
outcome of events.
For examp le, inforn1a t ion 3hout fin ancial posi t ion and
financial performa nce is fniq u ently used in predicting
dividend and wage psyrnents and t he nbility of the e ntity to
meet maturing commitme nt '> .
The net cash provided by opera ti ng acti,•ities is valua ble in
prerurting loan payment or default .
Financial information has cori fin11otor_v mlue if it provides
feedback about previous eva luation s.
ln other words, financial information has confir matory value
when it enables user s confi rm or correct earlie r expectations.
For ex?mple, a net income me as11re has confirmatory value if
it can help shareholders confirm or revi se their expectation
about an entity's ability to generate earnings.
Often, infor:nation has both pre dictive a nd confirma tory
value.
The predictive and confi rma tory roles of infor ma t ion are
interrelated.
An example is a n interim income state me nt which provides
feedback about income to date and serve s a s a ba si5 for
predicting the annual income.
If the i nte rim income state me nt fo r th e first quarter is
P2.000.~00 (confirm atory value), and this t rend contin ues for
the e nt1.re year, it. is logical to ass ume th at the ne t income
after_ f~ur quarters or o n e yea r would be P8,000,00 0
(predictive va luP.).
42
QUESTION 3-6
Explain m ateriality a n relation to re leva nce .
ANSWER 3-6
Materia lity is a practical rule in ac,;o un ting wluch dictate s
that st.rict adhere nce to GAAP is not r~ quired when the
items are not s igni fic a nt enough to affect the evaluation,
deci£ion and fairness of the fin anci al stateme nts. Materia lity
is also known as the doctrine of convenience.
Materinlity is really a "quantita tive threshold" linked very
d osely lo t he qual ita tive cha racte ristic of relrva nce.
The rclet.:ancc fJ[ in formation is a/fer.led !Jy its nature and
nw tc:·iality.
In oth er words , mate riality i!, q ··r, ubqual ity" of relev a nce
based on n at ure and mag ni tude of the item to which the
information relates .
Mal eriahty is a 1:elativity. Mate rialit;Y of an item depends on
relative size rather t han absolute size. \\' hat i:; materia l for
one entity may be immaterial fo r another.
An error of PI00,000 in th e financial s tatements of a
multinational entity may not be important but may l:,e so
critical for a small entit y.
QUESTION 3-7
When is an item material?
ANSWER 3-7
The Conceptual Framework does not specify a uniform
quantitative th reshold for materiality.
Very often. materiality is dependent on good judgment,
professional expertise and common sense.
However, a general guide may b~ given, to wit:
'_'A n item is material if knowledge of it would affect or
mfluence the decision of the informed users of the financial
s tatements'' .
{nformalion is material if the omission OI" misstatement could
influ.ence the econom ic decis ion that the u.sers make on the
basis of th e financial information about the entit.y.
43
QU ESTION 3-8
Illustrate the concept of materi a li ty.
ANS\VER 3-8
Small expenditures for tools are often expen~ed immedia~e ly
rather than depreciated over the use ful Life to sovc on cle ncal
costs of recording depreciu ti'l n beca use the effec t on the
financial 3tatements is not large enough to affect economic
deci sion.
Another example is the cummon practice of large entities of
rour:.ding amounts to the nearest thousan d pesos in the ir
financial statements. S ma ll e!1tities ma.r round off to th e
nearest pc!>o.
When all payments out of petty cash are de bited to
miscellaneous expense , rr. :~te ri ality is applied.
QUESTION 3-9
What are the factors that may be considered in determining
materiality?
ANSWER 3-fl
In the e>:ercise of judgmer,t in determining materiality, the
following factors may be considered:
a. Relative size of the item in relation to the total of the
group to which the item belongs.
For example, the amount of advertising in relation to total
di s tribution costs, or the amount of leasehold
imp:ovementi; in relation to total property, plant and
equipment.
b. Nature of th e item
An ite~ may be inherently material because by its very
na ture 1t affects economic decision.
For example, the.discovery of a P20,000 bribe is a ma terial
event even for a very large e ntity.
44
QUESTION 3-10
What is foithful representa tion?
ANSWER 3-10
Unde r the Conceptual Framework for Financial Reporti ng,
the term f u.ithf ul rep resentatwn is used instead of the term
relia bility.
Faithfu l re pre se nt ation mean s that financial reports
repres,mt economic phenomena or transactions in words and
numbers.
Stated diffe ren tly, the descriptions and figures match what
really existed or happened.
Simply worded, fa ithful representat ion means that the actual
effects of the t ransactions shall be properly accou nted for and
reported in the fin a ncial statements.
For example, if the entity reports purchases of P5,000,000
when the actual amount is PB,000,000, the information would
not be faithfully represented.
To record a sale of merchandise as misce llaneous income
would not also be a faithful represe·n tation of the sale
transaction.
When ending inventory is misstated, either understated
or overstated, the presentation or reporting lacks faithful
representation.
The recognition of an impairment loss on property, plant
and equipment is an application of faithful representation.
QUESTION 3-11
What are the ingredients of faithful representation?
ANSWER 3-11
To be a perfectly faithful representation, a depiction should
have three characteristics, namely:
a. Completeness
b. Neutrality
c. Free from error
45
QUESTION 3-12
. completeness of financial
Expl1un 1 statemen ts and the .related
standa rd of adequate disclos ure .
ANSWER 8-12
· es that relevant inform a tion should be
C.Ompletedn~ss reqauy1~!1at facilitate s understanding and avoids
presente Ill a w .
erroneous implicat10n.
\.)()mpIe te ness 1·s the result
If"'.
. of the adeq11aie disclosure standard
or the principle of full disclos1Lre.
The standard of adequate disclos_ure mea_n s t hat all
· ·r·,can t and relevant infor mat ion leadin
s1gm 1 l g to th e
preparation of financial stateme nts shall be c ea r Y reported .
Adequate disclosure however does not mean disclosure of
just any data.
The accountant shall disclose a material fact known to him
which is not disclosed in the financial statements but
di.sclos1ire of which is necessary in order that the statements
u;ould not be misleading
In other words, the standard of adequate disclosure is best
described by disclosure of any financial facts significant
enough to influence the judgment of informed users.
Actually, to be complete, the financial statements shall be
accompanied by "notes to financial statements".
The purpose of the notes is to provide the necessary
di sclosures required by Philippine Financial Reporting
Standards.
Notes to financial statements provide narrative description
or disaggre gation of the items prese nted in the financial
state me nts a nd information nbout items that do not qualify
for recog nition .
4S
QUESTION 8-13
Expla in neutrality of finan cial statements.
ANSWER 8-13
Neutrality mea ns that the financial stateme nts s hould not
be prep a red so as to fa vor one party to the detriment of
another party.
To be neutral, the information contained in the financial
statements must be free from bias.
A neu tral depictio n is "without bias" in the selection or
prescnt:1tion of financial information.
Ne utr a lity is syno nymous wit h the all -e ncompassing
"principle of fairness" . To be neutral is to be fair .
The information is directed to the common needs of many .
users and not to the particular needs of specific users.
QUESTION 3-14
Explain the characteristic of "free from error".
ANSWER 3-14
Free from error means there are no errors or omissions in
the description of the phenomenon, and the process used to
produce the reported information has been selected and
applied with no errors in the process.
In this context, free from error does not mean perfectly
accurate in all respects.
For example, an estimate of an unobservable price or value
cannot be determined to be accurate or inaccurate.
However, a representation of that estimate can be faithful if
t"'1e amount is described clearly and accurately as an estimate.
Moreover, the nature and limitations of the estimating
process are explained, and no errors have been made in
applying an a ppropriate process for developing the estimate.
47
QUESTION 3-16
Explain the concept of substance over form .
ANSWER 3-16
If information is to represent fai thfully the tran sactions it
purports to represent, it is necessary th at the trnn sactions
are accounted for in accordance with their eco nomic
substance and reality and not merely their legal form.
In other words, if there is a conflict between suhstance and
form , the economic substance of the t ra nsaction shall prevail
over the legal form.
The economic substance of transactions an d events are
· usually emphasized when economic substance differs from
legal form.
Substance ouer form is not considered a separate component
of faithful representation because it would be redundant.
Faithful representation inherently represents the substance
of an economic phenomenon or transaction rather than
merely representing its legal form .
QUESTION 3-16
What about conservatism?
ANSWER 3-16
There is no discussion of conservatism or prudence in the
Conceptual Framework for Financial Reporting.
The Conceptual Framework did not include conservatism or
prudence as an aspect of faithful representation because to
do so would be inconsistent with neutrality.
Most often, a conservative or prudent approach is subjectiue
and may contain an element of bias.
48
QU ESTION 3-1 7
EYpl ain the co ncept of conservatism .
ANSWER 3-17
Under con servatism, when al ternatives exist, the alternative
which has the least effect on equity shall be chosen.
Stated differently, managers, invest.ors and accountant~ have
generally preferred that possible errors in rnea3w-cmcnt be in
the direction of understatement_rather than overstatement of
net income and net assets.
In the simplest terms, conservatism means "in case of doubtr
rer..ord a ny loss and do not record any gain."
For "Jxample, if there is a choice between two accept.able asset
values, the lower figure is selccteci.
Accordingly, inventories are measured at the lower of cost and
net realizable value.
Contingent loss is recognized as a "provision" if the loss is
probable and the amount can be reliably measured.
Contingent gain is not recognized but disclosed only.
Conservatism is not a license to deliberately understate net
income and net assets.
QUESTION 3-18
Define prudence.
ANSWER 3-18
Conservatism is synony~ous with prudence.
Prudence is the desire to exercise care and caution when
dealing with the uncertainties in the measurement process
such that assets and incoII'e are not overstated or liabilities
and e-,..-penses are not understated.
49
QUES'flON 3-19
Explain the qualitative c-hnrncteristic of undNsta n dnb1lity.
ANSWER 3-19
Understandability requires t hat finnnci nl info rmati on must
be comprehensible or intelligible if 1t is ta be useful.
Accordingly, the inform a tion should be pr~sented in a form
and expressed in terminology that a user underst3 n<ls.
Classifying, characte1izi.ng and present ing information "clearly
a nd concisely" makes it un derst,rndable.
An essential quality of the informati'on provided in fin a ncial
statements is that it is readily understandable by users.
But the complex economic activities make it impossible to
reduce the financial information to the simplest terms.
Accordingly, the users s hould have a n understanding of the
complex economic activities, the financia l accounting process
and the terminology in the financial sta te ments.
Financial statements cannot realistically be understandable
to everyone.'
Financial report s are pre pared for users who have a
reasonable knowledge of business and economic activities and
who review and analyze the information diligently.
so
QUESTION 3-20
Exp lai n t he q unlitative characteris tic of comparability.
ANSWER 3-20
Comparability means the ability to brin e toeet he r for the
purpose of noting poin ts of like ness a nd d iffe re nce.
Comparability is the enhancing qualitative ch a racte ristic
t hat e nables users to ide n t ify a nd u nderstn nd s imi larities
a nd dissimilarities amo ng ite ms.
Compa rnb\li.ty may be made within an entity or between and
across enll ties.
QUESTION 3-21
What are the two kinds of com parabi lity?
ANSWER 3-21
The two kinds of comparability are comparability within an
entity an? comparabili ty across entities.
Comparability within an entity is t hP quality of inform a tion
tha t allows comparisons within a single entity through time
or from one accounting period to the next.
Comparability within an entity is nlso known as horizontal
comparability or intracomparabilit,y.
Comparability ac.ross entities is the quality of inform :- tion
that allows comparisons between two or more entities engaged
in the same industry.
T~is co.mparability is also known as intr.rcomparability or
dunenswnal comparability. ·
T?e fina ncial stat.cmcr:its of diffe rent e ntities are compared in
mder to e valuate their relative financi a l position, financial
performance and cash fl ows.
Users' decision s i~volve choosing between alternatives.
~onsequently, ~el~vant and faithfully represented info1·mation
is most useful 1f 1t _ca n be compared with similar information
~b?11t th~ same entity for the prcuio11s period and 1.J.Jith similar
t11/ormatwn reported by other entities.
51
QU ESTION 3-22
Explain the pi-inciple of consistency.
ANSWER 3-22
. . . h ,· tativc chaructci·istic
Implicit m t. e quail .
orcomparability is
the principle of consistency.
. . I f cons istency reqrii res tlit1 : !he <:icco un.t ing
The prrnctp e O •· d n1~orr1· b · .
methods an d prac~ices .~hou,ld be c,ppit..? on a IL , • as1.s
from period to perwd.
Consistency is not /he same a.s comparabilit)'.
Compa~ability is the goal and coilsist.ency hel ps to achieve
that goal.
Consistency is desirable and essential to a chieve
comparability of financial statements.
Technically, consistency i_s the uni~orm ~pplication_ of
accounting method from period to period withm an entity.
On the other hand, compar_a bilit.y is the uniform _appli~ation
of accounting method between and across entities m the
same industry.
An entity cannot use the FIFO method of inventory valuation
, in one year, the average method in the next year, another
method in succeeding year and so on.
If the FIFO method is adopted in one year, such method is
followed from year to year.
However, consistency does not mean that no change in
accounting method can be made.
If the change will result to more useful and meaningful
information, then such change should be made.
But there should be full disclosure of the change and the
peso effect thereof.
It is inappropriate to leave accounting policies unchanged
when better and acceptable alternatives exist.
52
Q UESTION 3-2 3
Explain verifiability.
ANSWER 3-23
Vei-ifiability mean s th at di fferent k nowledgeable and
indep ende n t observers could r each consensus that a
particular depiction is a fa ithful representation.
In other words, verifiability implies consensus.
The information is verifiable in the sense that it is supported
by evidence so that an accountant that wol,l.ld look into the
s am e e vidence would a rr ive at the sa me deci sion or
conclusion.
Verifiable financial information provides results that would
be substan tially duplicated by m easurers using the same
measurement method
QUESTION 3-24
Explain the enhancing quality of timeliness.
ANSWER 3-24
Timeliness means having information available to decision
makers in time to influence their decisions.
ln other words, timeliness requires that fi nancial informa tion
must be available or communicated early enough when a
decisic.,n is to be made.
Relevant and faithfu lly represented finan cial information
f1Lrn i:;hed after a decision is made is useless or of no value.
Rele~1ant information may lose relevance if there is undue delay
in. the reportin.g.
Timelim:ss ~nhance.s the truism that "without knowledge of
the past, the basis for prediction will usually be lacking and
without interest in the future , knowledge of the pa st is
sterile ."
Wha t happened in the post would become the basis of ruhat
would happen in the future.
53

QUESTION. 3-25
1. What are qll a litative characteristics of financial
Explain the cost constraint on useful inform ation.
ANSWER 3-25
Cost is a pervasive constraint on the information that can be
provided by financial reporting.
Report ing financial information imposes cost a nd it is
important that such cost is justified by the benefit derived
from the financial information.
In other words, the cost constraint is a consideration of the
. cost incurred in generating financial information against the
benefit to be obtained from having the information.
The benefit derived from the information should exceed the
cost incurred in obtaining the information.
Otherwise, the financial accounting information may not be
reported.
However, the evaluation of th e cos t constrai n t is a
judgmental process.
Assessing whether the cost of reporting outweighs or faUs
short of the benefit is difficult to measure and becomes a
matter of professional judgment.
54
QUESTION 3-26 Multiple choice (IAA)
st atc> mc nts':
t1. Qu 31i t otive ch a racte ristics are t he attr ibu tes that
make the inform a tion provided in financial sta temen ts
usefu I Lo users .
b. Qualitative ch ara cte ri s tics are broad classes of
financial effects of t ran sactions and other events.
c. Qualitati ve ch aracter istics are nonqualitative aspects
of fil1'tncial position a nd finan cial performan : e .
d . Qua lita tive ch::iracteristica me a sure the e xtent to
wh ich a n e n tity h as complied with a ll relev a nt
stnnda rd s an d interpretations.
'.2. Qual itative characteristics
a. Are considered either fundamenta l or enhancing.
b. Con t l' ibu te to the dec ision -usefulness of financial
re port ing information .
c. Disti ngui s h be tter in fo r m at io n from inferior
infor mation for decision-m a king pu rposes.
d . All of t.he choices a re correct.
3. The fu ndamental qualitative ch a racteristics are
· a. Re levance a nd fa ithful repre se n tation
b. Relevance, fai thful representat ion a n d materiality
c. Relevance a nd relia liili ty
d. Faith ful 1epresent a tion a nd materiality
1. Accounting infor mation is considered relevant when it
a . Cn n be de pe nded '.l pon to rep re sen t the economic
con ditions and eve nts that it is inte nded to represent.
b. Is cap able of maki ng a diffe re nce in a deci1,ion.
<'. Is understur:dable by reasonab ly informed users.
d . ls verifia ble nnd neutral.
5. The ing:.!edi ent s of relev a nt financial i.nf~rmation are
a. Predictive val ue und confirma tory value
b. PrNlictive v_alue, confi r matory value and timeliness
C. PreJ ictive value , confi r matory value a nd m at eriality
d . P r1; J1cttve v ahJI:) , confirma tory valu e and timeliness
55
 . i·t of information thn t gives ass uranc.. QUESTION 3-27 Multiple choice (IAA)
6. Wh at 1s the qua 1 Y d b' · ?
that it is reasonably fre e from error a n 11\S.
L The enhan c ing qualitative characteristics of financial
a. Releva nce . information are
b. Faithful representat10n
c. Ve rifiabili ty a. Comparability and understandability
d. Neutrality b. Verifiability and timeliness
c. Comparnbility, unders ta nd a bility and verifiability
7 Which of the following is the best descri_p tio~ of faith ful d. Comparability, und erstanda bili ty, verifiability and
· represe ntation in relat ion to information m finan cial tim eliness
stateme nts?
2. Financial information exhibits consistency when
a. Influence on the economic deci sion of users
b. Inclusion of a degree of ca ution a. Accounting procedures are adopt ed which s mooth ne t
c. Freedom from 'material error income and make resulti:, consistent between years.
d. Comprehe nsibility to users b. Gains and losses are sh ow n separately in the income
statement.
8. The ingredients of fa ithful representation are c. Accounting entities give similar even t s the same
a. Completeness and neutrality accounting treatment each period.
b. Completeness a nd free from error d . Expenditures are reported as expenses and netted
c. Completeness, neutrality and free from error against revenue in the period when paid.
d. Completeness , neutrality, free from error an d
conservatism 3. -When information about two different entit i es
engaged in the same industry has been prepared and
9. The financial accounting information is directed toward the presented in similar manner, the information exhibits the
common needs of users and is independent of presu,aptions enhancing qualitative characteristic of
about particular needs a nd desires of specific users.
a. Relevance
a. Relevance b. Faithful representation
b. Verifiability c. Consistency
c. Neutrality d. Comparability
d. Completeness
4. The characteristic that is demonstrated when a high
ANSWER 3-26 degree of consensus can be secured among independent
measurers u3ing the same measurement method is
1. a 6. b
2. d 7. C a. Rele"ance
3. a 8. C b. Unde rstandability
ti . b 9. C c. Verifiability
fi. a d. Neutrality

56 57
 . holds that, to the maximum
5. Which concept of _accou~ti°:Catements shall be ba se d on QUESTION 8-28 Multiple choice (IAA)
extent possible, fina n_c1a ?
arm's length tra nsactions . 1. The overriding qualitative characterist ic of accounting
a.
Revenue realization infor mation is
b.
Verifiability .
c.
Monetary unit a. Relevance
d.
Matching b. Understandability
c. Faithful representation
• · the annual fina nci:11 repor ts within one
6. An entity itshs wngd of repo rtino period \S an example of d. Decision usefulness
month at e en " · · ti ?
which enhancing quali ty of accounting rn orm a .on . 2. Which of the following terms best describes information
that infl uences the economic decisions of users?
a. Neutrality
b. Ti meli ness
c. Predictive value a. Reliable
d. Representational fa ithfulness b. P rospective
c. Relevant
7. Allowing entities to estimat~ ra_ther than ph ysifca11y cdo unfft d. Understa ndable
inventory at an interim period 1s an examp 1e o a tra eo
between 3, What is the quality of information that enables users to
better forecast future operations?
a. Verifiability and com parability
b. Timeliness and comparability a. Faithful representat ion
c. Timeliness and verifiability b. Materiality
d. Neutrality and consistency c. Comparability
d. Relevance
8. Which sta tement is true in rel a tion to the enhancing
qualitative charac teristic of understandability of
financial information? · 4. Which of the following terms best describes infor mation
in financial statements that is unbiased?
a. Users have a reasonable k nowledge of business and
economic activities and nwiew the information v,ith a. Unders tandable
reasonable dilige nce. b. Comparable
b. Users are expected to have si gn ifi can t i:a, s ineas c. Relevant
k nowledge. • d. Neutral
c. F!nanc!al statements shall exclude com plt x mat te rs.
d. Fma ncrnl statements shall be free from ma teri al error. 5. For information to be useful, the linkage between the users
and the decisions made is
ANSWER 3-2 7
J. d a. Relevance
5. b
2. <: 6. b b. Faithful representation
3. d 7. C c. Understandability
4. r, 8. a d. Verifi ability

58
 F
6. An enhancing quality of fin a ncial ac counting QUESTION 3-29 Multiple choice (IAA)
information is that
1. An item would be considered material when
a. Information must be de~ision-useful to a ll potential
users of financial report.mg. . . . . a . The expected be nefits of disc losure exceed t he
b. Gene ral-p urpose ~na ~c1al reporting 1s the. prima ry additional costs.
source of information 1or users. . b. The impact on earnings is greater than 10%. _
c. Users need reasonable knowledge of business and c. The standard definition of materiality is met.
financ ial accounting matters to u n de rstan d the d. The omission or misstatement of the amount would
inform ation contained in fin ancial sta tements.
d. All of the choices are correct. make a difference to the users.

7. What is meant by comparability when dis cussing 2. Which s tatement about materiality is true?
financi al accounting infor mation?
a. An item must make a difference or it need not be
a. Informa tion has predictive and confirmatory value. disclosed .
b. Information is reasonably free from error. b. Materiality is a matter of relative size.
c. Information is me as ured and rep0rted in a similar c. An item is material if the inclusion or omission would
fashion across entities. influence or change the judgment of a reasonable
d. Information is timely.
person.
8. What is meant by consistency when discussing financial d. All of these statements are true about materiality.
accounting inform ation ? ·
3. The Conceptual Framework includes which of the
a. Information is me asured and reported in a similar following constraints?
fashion across points in time.
b. Informa tion is timely. a. Prudence
c. Information is measured similarly across the industry.
d. Information is verifiable. b. Substance over form
c. Cost
9. Which of the following is not a n enhancing qualitative d. All of the choices are constraints
characteristic?
4. Which statement best aescribes the cost and benefit
a. Understanda bility constraint?
b. Profit-oriented
c. Timeliness a. The benefit of the information must be greater than
d. Comparability the cost of providing it.
ANSWER 3-28 b. Financial information should be free from cost to users
of the information.
I. d 6. C c. Cost of providing financial information is not always
2. C 7. C evident or measurable but must be considered.
a. d 8. a d. All of the choices are correct.
4. d 9. b
5. C

61
6-0
5. Conservatism is best described as selecting an accounting QUESTION 3-30 Multiple c hoic e (AICPA Adapted)
alternative that
l . The ability th rough conse nsus among measure rs to ens ure
th at information represents what it purports to represent
a. Understates assets and net income .
b. Has the least favorable impact on eqmty i~ an example of the concept of
c. Overstates liabilities a. Releva nce
d. Is least likely to mislead users of financial informatiori b. Veri fi ability
c. Compa rability
6. The Conceptual Framework d. Feedback value
2. Which of the following accounting concepts states that
a. Includes prudence or conservatism which means when an accou nting transaction shall be supported by sufficient
in doubt, choose the solution that will be least likely evide nce to allow two or more qualified individuals to
to overstate assets and income. arrive at essentially similar conclusion?
b. Includes prudence or conservatism which means when
in doubt, choose the solution that will be least likely a. Conserva tism
to understate liabilities and expenses. b. Objectivity
c. Includes prudence or conservatism as a desirable but c. Periodicity
d. Stable monetary unit
not required quality of accounting information.
d. Excludes prudence or conservatism because it is 3. Objectivity is assumed to be achieved when an accounting
inconsistent with neutrality. transaction

ANSWER 3-29 a. Is recorded in a fixed amount of pesos

b. Involves the payment or receipt of cash
c. Involves an arm's length transaction between two
1. d
independent parties
2. d d. Allocates revenue or expenses in a rational and
3. C systematic manner
4. a
5. b 4. Proponen ts of hi s torical costs maintain statements
6. d prepared using historical costs are more
a. Objective
b. Relevant
c. Indicative of purchasing power
d. Conserva tive
5. Wh ich statemen t is an argument against historical cost?
a. Fair value is more relevant.
b. Historical cost is based on exchange transaction.
c. . Hi storical cost is verifiable and reliable.
d. Fair value is subjective.

62 63
6. \Vhich of the following situations violates the concept of
faithful representation?
a. Financial statements were issued nine months late.
b. Data on segments having th!? same expected risks and
growth rate~ are reported to analysts estimating future
profits. . . .
c. Financial statements included an item of property
plant and equipment with carrying amount increased
to management estimate of market value.
d. Management reports refer to new projects undertaken
but the financial statements never report project
results. ·

7. What is the underlying concept governing the generally

-accepted accounting principles pertaining to recording
gain contingencies? _ · ·
a. Conservatism
b. Relevance
c. Consistency
d. Reliability

8. The usefulness of ·providing information in financial

statements is subject to the constraint of
a. Consistency
b. Cost-benefit
c. Reliability
d. Representational faithfulness
ANSWER 3-30

1. b 5. a
2. b 6.
s. C 7.
C
a
4. a 8. b

64
CH AP TE R4
CON CEP TUA L FRA MEWO RK
Elem ents of fin'a .n cial stat eme nts
QUES TION 4-1
What is the mea ning of recogn ition?
ANSWER 4-1
Recog nition is a term \vhich means the proces s of report ing
an asset. liabili ty, incom e or expen se on the face of the
financial statem ents of an entity .
In other words , recogn ition involv es the inclus ion of peso
amount in the financ ial statem ents.
QUESTION 4-2
What are the eleme nts of the financ ial statem ents?
ANSWER 4-2
The elem ents of finan cial state ment s refer to the
quanti tative inform ation shown in the statem ent of financ ial
position and statem ent of compr ehensi ve incom e.
~he eleme nts direct ly relate d to the meas ur'e ment of
financial positio n are assets , liabili ties and equity .
T,he eleme nts direct ly relate d to the meas urem ent of
,inanc ial pe,-for niance are incom e and expen ses. •
Tb he eleme nts of financ ial statem ents are the "build ing
1ocks" from which financ ial statem ents are constr
ucted.
The eleme nts of financ ial statem ents are broad classe s of
events ';)r trans~ ctions that are group ed accord ing to their
economic charac teristi cs. ·

65
 >
QUEST ION 4-5
QUEST ION 4-3
·lit.}' equity , income a nd c xpen!'le. Explain the a s se t recognit ion principl e.
D e (jm e asse t, li a b 1 ,
ANSWE R 4-6
ANSWE R 4-3
Asset is defined as r eso urce controU~tl h~ th e e n t ity as 8 An asset is 1·ecogniz ed in the stateme nt of financia l position
a. result of past eve n t and from whi ch_ tu tu re eco nomic when it is probable that future economi c benefits will flow to
benefit are expected to flow to the e ntity the entity and the asset has a cost or value that can be measure d
reliably.
b. Liabilit y is presen t obligat ~on ho~ thhe e ntitj tet>rdis;ng from
past event t he settle ment o._w " : is e ...:pee -0 t eoult
'fhus, two conditio ns must be present for the recognit ion of an
in an outflow from the e n tity ot r eso u rces e m bodying
asset:
economic benefits .
8. It is probable that future economi c benefits wiU flow to the
c. Equity is the residual inte~es~ ~n. t he as se ts cf the entity entity.
after deductin g all of the h a b1hties.
b. The cost or value of the asset can be measure d reliably.
d. Income is in crease in econo m ic bene fi t during the
accounti ng period in the form of an inflow or _increase of
asset or decrease of lia bility t ha t results in inci:ease in QUEST ION 4-6
equity, other than contribu toin from equity particip ants. What is the cost principl e?
e. Expens e is decrea se in econom ic benefit during t he
accounti ng period in t he form of an outflow or decrease ANSWE R 4-6
of asset or increase of liability that results in decreas e in
equity, other th a. n distribu tion to equity particip ants. Inheren t in asset recogni tion is the cost principl e.
This principl e require s that assets shall be recorde d initially
QUESTION 4-4
at original acquisit ion cost.
What are the conditio ns that must be presen t· for the
recognit ion of an item that meets the definiti on of an The initial cost may be carried withou t change , may be
element ? changed by depreci ation, amortiz ation or writeoff , or may
be shifted to other categor ies as in the case of raw materia ls
ANSWE R 4-4 being convert ed into finished goods.
An item that meets the definitio n of 'an elemen t shall be
recogniz ed when: In other words, the financia l stateme nts shall be based on
histori cal cost rather than market value.
l. It is probable that any future economi c benefit associat ed·
with the item will flow to or from- the entity. The reason is that cost is objectiv e and therefor e verifiab le
2. T~e. it~n:i has a cos t or value tha't can be m e asured with while market value is subjecti ve.
rc1liab11I ty.

67
66
 ►
QUESTION 4-7 QUEST ION 4-9
E'll."l)lain the liability recognition principl e. Distingui~h income from revenue and gains.
ANSWE R 4-7
l position ANSWE R 4-9
· gru·,.,,d in the statemefnt of financia
A li 8 bi.ti.ty 1s reco ""' fl ,
when it is probable that an out_ o,dv ~ r:hour~f tl ~<';~not ~tg
b d ·
ba
The definition of income encomp asses both revenue and gains.
economic benefits will be requir~ iof r l e bsli tic!·
present obligatio n a nd the amount o t 10 o ga ion can e Revenu e arises in the course of the ordinary regular activitie s
measure d reliably. and il:l referred to by a variety of differen t names includin g sales,
fees, interei:1t, dividends, royalties and rent.
111US, two condition
rJ'\.. s must be present for the recognition of a
liability: · The essence of revenue i.s regular ity.
It is probable that an outflow of economic ~ene?ts will be Gains represen t other items that meet the definitio n of income
a. required for the settleme nt of a present obligation. and do not arise in the course of the ordinary regular activities.
b. The amount of obligatio n can be measure d reliably.
QUEST ION 4-10
QUESTION 4-8
Explain the recogni tion of reve nue fro m interest ,. r~yaltie s,
Exp lain the income recogni tion princip le or realizat ion dividends, installa tion fees, s ubscript ion fees, adm1ss1on fees
principl e. and tuition fees.
ANSWER 4-8 ANSWER 4-10
The basic principle is that "income shall be recognized when 1. Interest revenue shall be recognized on a time proporti on
earned". basis that takes into account the effectiv e yield on the asset.
But the question is when is in.come considered to be earned? 2. Royalti es shall be recogni zed on an accrual basis in
The Conceptu al Framew ork provides that income is recognized accordance with the substan ce of the relevant agreeme nt.
when it is probable that a11 increase in future economic benefits
related to an increase in an asset or a decrease in a liability has 3. Dividen ds shall be recogni zed as revenue when the
arisen and tha t the increase in econom ic benefits can be shareho lder's right to receive paymen t is establis hed,
measured reliably. meaning , when th~ dividend s are declared .
'.fhus, two conditions must be present for the recognit ion of 4. Installa tion fees are recognized as revenue over the period
income: of installat ion by reference to the stage of completion.
a. It is probable that future economic benefits will flow to the 5. Subscri ption fees should be recogni zed as r evenue on a
entity as a result of an increase in an asset or a decrease in straight line basis over the subscrip tion period .
a liability.
6. Admissi on fees are recognized as revenue when the event
b. The economfo benefits can be ·measur ed reliably. takes place.
Undoubtedly, both conditions are present at the point of sale. 7. Tuition fees are recogniz ed as revenue over the period in
Accordingly, the point of saJe is the point of revenue recognition. which tuition is provided.

68 69
QUEST ION 4-11
- QUESTION 4- 18
Explain the expense recognition principle.
Wha t do you underst11nd by the matchin g principl e?
ANSWER 4-11 ANSWER 4-18
T he Co nceptu al Framew ork provide s that expe_nses a re
recognized when it is p robable th a t a d~c rease m fut ure The expense recogni tion principl e is the applica tion of the
economi c benefits rela ted to a decreas e rn an ~ssct or an matchi ng princip le. ·
increase in liability has occurred and the decrease m economic
The generati on of revenue is not without any cost. There has
benefits can be measure d reliably.
got to be some emit in earning a revenue .
Thus, two conditions must be present for the recognit ion of
"There is no gain if there is no pain".
expenses:

a. It is probable that a decrease in future economic benefits The matchin g principle requires that those costs and exp enses
has occurred . incurred in earning a revenue should be reported in the same
period.
b. The decrease in economic benefits can be measure d reliably.
In other words, there should be simulta neous or combin ed
QUESTION 4-12 recognit ion of revenue s and expense s that result directly from
the same transact ions and events.
Distinguish expenses and losses:
In other words, there should be simulta neous or combin ed
ANSWE R 4-12 recognit ion of revenue and expense s that result directly from
The definiti on of expense encompasses losses as well as those the same transact ions and events.
ex~e?~es that arise in the course of the ordinar y regular
act1V1t1es of the entity. The basic expense recognit ion principl e means that "expens es
are recogniz ed when incurred".
Expenses that arise in the course of ordinary regular activitie s
?f the entity include, for example, cost of sales wages and But the question is when are expenses incurred?,
depreciation. '
Expense s are incurred in conform ity with the three applica tions
Losses represe nt other items that mee t the definiti on of of the matchin g principl e namely:
ex~e~~es and do not arise in the course of the ordinary regular
act1V1t1cs of the entity. a. Cause and effect associat ion
b. Systema tic and rational allocatio n
Examples include losses resulting from disaster s such as fire c. Immedi ate recognit ion
• fro
and flooc as well as th ose a n·smg .
assets. ' m disposal of noncurr ent

70 71
QUESTION 4-14
. the cause d effect association principle.
Explam
nn
ANSWER 4-14
The cause and effect associatio n prin?iple means that the
•
expense 1s reco gnized when the
. revenue ·1st alreudy
· f hrecogm.,,,.d
..._
on the basis of a presumed direct assocrn wn o t e expense
with specific revenue.
The cause and ~ffect association principle is actually the "strict
matching concept".
The best example is the cost of merchandi se inventory. Such
cost is considered as an asset in the meantime that the
merchandise is on hand.
When the merchandise is sold, the cost thereof is e>.l)ensed in
the form of "cost of sales" because at such time revenue may be
recognized.
Other examples include doubtful accounts, warranty expense
and sales commissions.
QUESTION 4-15
Explain the systematic and rational allocation principle.
ANSWER 4-15
Under the systemati c and rational allocation principle ,
so~e costs al'e expensed by simply allocating them over the
periods benefited.
The reason for this principle is that the cost incurred will
benefit future periods and that there is an absence of a direct
or clear association of the expense with specific revenue.
Wl,~n economic benefits are expected to arise ouer several accounting
f!Crt~ and the ~sociation with income can only be broadly or
uidirectl:'(' determuied, e."Cpenses are recogn'i.zed on the basi,s
systematic and all-Ocation procedures.
Concrete examples include d
a llocation of prepaymen ts. epreciation , amortizat ion an d
72
QUESTIO N 4-1 6
Explain the . immediate recognition principle.
ANSWER 4-16
Under immed iate recognitio n principle , the cost incurred
is expensed o utright becau se of uncertain ty of future
economic benefits or difficulty of reliably associating certain
costs with future revenue.
Actually, t his principle reflects a conservati ve or prudent
approach which is t he accountant 's general guide for dealing
with uncertain situations.
An expense is recognized immediate ly when an expenditur e
produces no future economic benefits or when ~uture
economic benefits do not qualify, or cease to qualify for
recognition in the statement of financial position as an asset.
QUESTIO N 4-17
Give examples of expenses that are recognized immediate ly.
ANSWER 4-17
Examples include officers' salaries and most administra tive
expenses, advertisin g and most distributio n costs, amount
to settle lawsuit and worthless intangible assets.
Many losses, such as loss from disposal of building, loss from
sale of investmen ts, and casualty loss, are immediate ly
recognized because they are not directly ,related to specific
revenue .
QUESTIO N 4-18
Explain "mea sureme nt" of the elements of financial
statement s.
ANSWER 4-18
1
0
Measurem ent is the process of determinin g the monetary
a mounts at which the elements of the financial statement s
a re to be recognized and carried in the statement of fin a ncial
position and income statement .
73
QUESTION 4-19 QUESTION 4-20 Multiple choice (ACP)
Explain the four measurement bases or financial attributes.
1. The e lements directly r elated to the measurement of
financial pos ition are
ANSWER 4-19
a. Assets, liabilities, equity, income and expense
The four measurement bases are historical cost, current cost, b. Assets, liabilities and equity
realizable value and present value. c. Income and expense
d. Assets and liabilities
Historical cost is the amount of cash or cash equivalent
paid or the fair value of the consideration given to acquire 2. The elements directly related to the measurement of
an asset at the time of acquisition. financial performance are
a. Assets, liabilities, equity, income and expense
Historical cost is also known as "past purchase exchange b. Assets, liabilities and equity
price." c. Income and expense
d. Sales and cost of goods sold
Historical cost is the measurement basis most commonly
adopted by entities in preparing their financial statements. 3. It is a resource controlled by the entity as a result of past
event and from which future economic benefits are expected
Current cost is the amount of cash or cash equivalent that to flow to the entity.
would have to be paid if the same or an equivalent asset was a. Asset
acquired currently. b. Liability
c. Equity
Current cost is also known as "current purchase exchange d. Income
price".
4. It is a present obligation of an entity arising from past
Realizable value is the amount of ca8h or cash equivalent event the settlement of which is expected to result in an
that could currently be obtained by selling the asset in an outflow from the entity of resources embodying economic
orderly disposal. benefits.
a. Asset
Re_ali.~able value is also known as "current sale exchange b. Liability
pnce. c. Equity
d. Expense
~resent value is the discounted value of the future net cash
inflows that the item is expected to generate in the normal 5. It is th~ residual interest in the assets of the entity aftet
course of business. deducting all of the liabilities.
a. Income
Present value is also known as "future exchange price".• b. Expense
c. Net income
d. Equity

74 75
 · an increase
6 . I t 1s · 1·n economic benefit during t hed accounting
•
· d l 8 t d to a n increase in asset or a ecrease 1n QUESTION 4-21 Multiple choice (ACP)
peno e
liabilityrethat results in increase rn·
equi Y othc t· th an
't
1. It is the process of incorporating in the stateme nt of
contribution from owners. financial position or statement of comprehensive income
an item that meets the definition of an eleme nt of the
a. Asset financial statements.
b. Liability
c. Income a. Recognition
d. Expense b. Measurement
c. Realization
7. It is a decrease in economic be~efit dutng the _accounti1_1g d. Allocation
period related to a decrease m as~e or ~n increase in
liability that r esults in decrease m equity other than 2. When should a n item that meets the definition of an
element be recognized?
distribution to owners. ·
a. When "it is probable that any future economic benefit
a. Asset associated with the item will flow to or from the
b. Liability entity.
c. Income b. When the element has a cost or value that can be
d. Expense measurfed with reliability.
c. When the entity obtains control of the rights or
8. This arises in the course of ordinary regular activities obligations associated with the item. .
and is referred to by a variety of different names including d. When it is probable that any future economic bene_fit
sales, fees, interest, dividends, royalties and rent. associated with the item will flo~ to or from the entity
and the item has a cost or value that can be measured
a. Income with reliability.
b. Revenue
c. Profit 3. An asset is recognized when
d. Gain a. It is probable that future economic benefit will flow
to the entity.
9, Which statement in relation to income is true?
a. Income encompasses both revenue and gain.
~'. +g: ~~~!:
the asset.
ili;
;baf:i~~~~1:iet:;.8~i r~:hl:!!~~~!~!~ ~lfh
.
b. Revenue encompasses both income and gain. d. It is probable that future economic benefit will flobw
c. Gain encompasses both income and revenue. to the entity and the cost or value of the asset can e
d. Income is the same as rever.ue . measm·ed reliably.

ANSWER 4-20 4. A liability is recognized when

1. b 6. C
a. It is probable that an outflow of futu~e e~oriomic
2. C 7. benefit will be required to settle the obligation:
d b. The amount of the obligation can measured rebabl:r.
3. a 8. b C. It is probable that an outflow of futur~ e~onom1c
4. b 9. a benefit will be required to settle an obligatio~ and
5. d the amount of the obligation can be measurE:d rt:hably.
d. When the entity obtains control of the obligation.

76 n
5. An income is recognized when 9. An expense is recognized immediately
It is probable that future econom_ic benefi~ will flow
a. to the entity and the economic benefit can be a. When an expenditure produces no future economic
benefit.
measured reliably. . fi ·u fl
· poss1'ble that future economic bene bt w1 ow to b. When cost incurred ceases to qualify as an asset. ·
b. I t 1s .
the entity and the economic bene 6 t can e measured c. When an expenditure produces future economic
benefit.
reliably. l f h f t .
c. The entity obtains contro o t e u ure economic d. When an expenditure produces no future economic
benefit and when cost incurred ceases to quality as
d. ~t~efu~~re economic benefit can be measured reliably. an asset.

6. An expense is recognized when 10. It is the process of determining the monetary amounts
a-. It is probable that a decrease in future economic at which the elements of the financial statements are
benefit has occurred. recognized in the financial statementi;.
b. The decrease in future economic benefit can be
measured reliably. a. Measurement
c. It is probable that a decrease in future economic b. Recognition
benefit has occurred and the decrease in the future c. Presentation
economic benefit can be measured reliably. d. Recording
d. It is probable that an increase in future economic
benefit has occurred and the increase in future
ANSWER 4-21
economic benefit can be meas ured reliably.

7. It is the process that involves the simultaneous or 1. a 6. C

combined recognition of revenue and expenses that result 2. d 7. a
directly from the same transactions and other events. 3. d 8. b
4. C 9. . d
a. Matching of cost with revenue 5. a 10. a
b. Matching of revenue with cost
c. Systematic and rational allocation
d. Immediate recognition

8. When economic benefits are expected to arise over

several accounting periods and the association with
income can only be indirectly determined, expenses are
recognized on the basis of

a. Cause and effect association

b. Systematic and rational allocation
c. Immediate recognition
d. Realization

78 79
 QUESTION 4-22 Multiple choice (IAA)
QUESTION 4-23 Multiple choice (IAA)
1. Which measurement is n ot currently used in practice?
1. Asset measurements in financial stateme nts
a. Present value
b. Net realizable value a. Are confined to historical cost
c. Current replacemen t cost b. Are confined to historical cost and current cos t
c. Rl':! flect several financial attributes
d. Inflation-adjusted cost d. Do not reflect output value
2 _ Which measurement attribute is the mos t relevant?
2. Which of the· following should be considered a curre nt
a. P resent value value measure?
b. Exit value
c. Curren t cost a. Replacement cost and exit value --. ,
d., Historical cost b. Rep lacement cost a nd discounted cash flow
c. Exit value a nd discounted cash flow
3. It is the amount of cash that would have to be paid if d. Replacement cost, exit value and discounted cash flow
asset was acquired currently.
a. Historical cost 3. The primary measurement bas is is
b. Current cost a . The current market pi-ice if the asset currently held was
d. Realizable value sold on the open market.
d. Present value b. The curre n t market price if the asset held was
purchased on the open market.
4. Which term best describe~ the amount that represents c. The present value of the cash flows that the asset is
the immediate purchase cost of an asset? · expected to g1:::nerate.
a. Historical cost d . The market price at the date the asset was acquired.
b. Realizable value
c. Present value 4. Which measurement basis is currently used in financial
d. Current cost statements?

5. It is the amount of cash that could currently be obtained a. Present value

by selling the asset in an orderly _disposal. b. Present value and settlement value
c. Settlement value and fair value
a. Realizable value d. Present value, :3ettlement value and fair value
b. Fair value
c. Market value ANSWER '4-23
d. Present value
1. C
ANSWER 4-22
2. d
I. d 3. b 5. a 3. d
2. a 4. d 4. d

80 81
QUEST ION 4-24 Multipl e choice (IAA)
6. \\'hich of the following may not be an accepta ble deviatio n
1. Which stateme nt describ es the reve nue recogni tion from recognizing revenue at the point of sale?
principl e?
a. Upon receipt of cash
a Cash is received.
· I 15
• b ble that future economi·c bene fi t w ill fl ow to b. During product ion
b. th Pt:'tya nd c. Upon receipt of order
t e entl a tlie amount can be measure
·
d reliably.
f d. End of product ion
c. Production is complete and there 1s an ac 1ve market
for the product.
d. Production is complete. 7. Whic h of the followin g is not an accepte d basis for
recognition of revenue ?
2. The revenue princip le states that revenu e shall be
recognized at a point when a. Passage of time
b. Perform ance of service
a. An exchange transact ion has occurred and the earning
c. Comple tion of percenta ge of a project
process is essentially complete. . . d. Upon signing of contract
b. An order for shipmen t of merchandise has been received.
c. A contract between buyer and seller has been signed.
d. The seller has shipped merchan dise under terms that 8. Which of the followin g repre se nts the least desirab le
the customer need not pay until sold. choice for t he recogni tion of revenue ?

3. Generally, revenue is recognized a. During product ion o- ·

b. When a sale occurs
a. At the point of sale. c. When cash is collecte d
b. When cause and effect are associated. d. When product ion is comple ted
c. At the point of cash collection.
d. At appropriate points through out the operatin g cycle. 9. Revenue from an artistic perform ance _is recognized when
4. Normally, revenue from sale of goods is recognized a. The audienc e register for the event online.
a. When the customer order is received. b. The tickets for the concert are sold.
b. When the customer order is accompanied by a check. c. Cash has been received from the ticket sales.
c. Only if the transaction will create an account receivable. d. The event takes place.
d. Wh~n the title to the goods changes. ·
ANSWER 4-24
5. Revenue may be recognized
1. b 6. C
a. At the point of sale 2. a 7. d
b. During production 3. a 8. C
c. At the end of production 4. d 9. d
d. All of the choices may be . 5. d
recognition accepta ble for revenu e

82
83
QUESTIO N 4-25 Multiple choice (IAA)
QUCSTIO N 4-26 Multiple cho ice (IAA)
• d
1. Income recognize usin g the insta1llm en t method of
· r d b 1. The installmen t method. of recogni2.ing revenue
accounting equals cash collected mu tip ie y
a. Should be used when no reasonable basis exis ts for
es ti1,1ating t he collcctibili ty .
8 Net profit rate •bl b. Is not a gener:.illy accepted accou nting principle under
b.· Net pro fit ra te adJ·usted for uncollecti e accounts ;:w v circumA tances.
Gross profit rate . C. S hould be used for tax purposes.
~-- Gross profit rate adjusted for uncollect1ble accounts d. ls a n accept able alte rnative accounting principle.
z. UnclE: r which circumsta nce is the insta llment method
2. U n der the installmen t method of
. daccounting
. . , gross profit appropi-ia lc for thE:: recog nition of revenue?
on an installment sale is recogmre m income
a. For any sa le s where collection is s pread over a
a . On the date of sale. reasona ble long periou of time.
b: On the date the final cash collec_tion is received. b. In any situation wh ere manageme nt wishes to delay the
c. In proportion to the cash collection. recognition of reven ue in order to smooth income.
C. For saJe3 where collection is spread over a reasonable
d. After cash collections equal to the c~st of goods sold long period of time and significant doub~ exists about
have been received. ultimate collection of installme nts receivable .
d. For sales where collection is spread over a reasonable
3. Under the cost recovery method of accounting , gross profit long period of time a~d no ~ignifican t doubt_ exists
on an installmen t sale is recognired about ultimate collect1on of installmen ts receivable.

a. After cash collections equal to the cost of goods sold 3. When using the installmen t method
have been received a . Gross profit is deferred until a ll cash is received. ·
b. In proportion to the cash collection . b. Gross profit is recognized only a fte r the amount of
c. On the date the final cash collection is received cash collected exceeds the cost of goods sold.
d. On the date.of sale · c. Revenue, costs and gross profit are recognize d
proportion ally as ca sh is received from the sale.
d. Total revenue ,;md costs are r ecognized at the point
4. Which statement justifies the use of the cost recovery of sale but gross profi t is deferred in proportion to
method to account for installmen t sales? the cash that is uncolJecte d from the sale.
a. The sales contract provides that title only passes to the 4. The cost recovery method of revenue recognition
purchaser when all payments have been made.
b. No cash payments are due until one year. a. Is used only when ci.rcuQ1stances surromulin g a sale are
c. Sales are subject to a high rate of return. so uncertain that earlier recognition i3 impossible.
d. There is no reasonable basis for estimating collectibility. b. Is used in accounting for real estate sales.
c. Is similar to percentage of completion accounting .
ANSWER 4-25 d. Is never acceptable under GAAP.

1. C ANSWER 4-26
2. C 1. a
3. a 2. C
4. d 3. d
4. a

84 85
QUESTION 4-27 Multiple choice (AICPA Adnpted)
6. Which statement confo1·ms lo the realization concept?
l. 1'ht> term "t'\.'vcn.nc i-eco~ni tion" conventionally refors to
a. Deprecia tion was assigned to product unit cost
a. f'l'h
i
-~ f identilYing. trnnsuctionR
f' pi•ocC'::-~ t1 .· d
to be recot·ded b. Eequipme nt was sold in excha nge for a note receivable
·,s revenutl in an »ccountmg pet 10 • . c. Cash was collected on Accounts receivable
~ The process of measuri ng a nd rdatmg r~venue and d. Product unit cos ts were assigned to cost of goods sold
. , s of an ent.i ty for an acoount m~ pE:noci.
expen$e •h · . se t o 1•cvenue
c 'l'he ea rning process w 111c g1ves 11 7. Revenue muy result from
realization. · 1
d. The process of identifyi ng t hose tran~n~t1ons t u1t result A decrease in an as8et from primary operations.
11 •
in a n inflow of assets from customers. b. An increase in an asset from incidental transactions.
c. An increase in a liability from incidental transactions.
2. Under what. condition is it proper to recognize revenue prior
to the· sale oft.he merchandise?
d. A decrease in a liability from primary operations.

a. When the concept of consistency is oomplied with. 8. When s hould an entity use the insta llm e nt method of
b. When the revenue is to be reported asdan installment sale. revenue recognition?
c. When the ultimate sale of the goo s is at an assured
sales price. a . When collectibility of installment accounts receivable
d. When management has A long-es~blished policy. is reasonably predictable.
b. When repossessions of merchandise on the installment
3. Which term means the process of converting noncash plan may result in a future gain or loss.
resources and nghts into cash or claims to cash? c. When t here is no reasonable basis for e stimating
a. Allocation collectibili ty.
b. Collection d. When collection expenses are deemed immaterial.
c. Recognition
d. Realization 9. The installme nt method of accounting may be u·s ed if the

4. Gains on assets unsold are identified in a pr ecise sense by 2. Collection periotl extends over more than 12 months
the term b. Installments are due in different years
a. Un recorded c. Ultimate amount collectible is indeterminate
b. Unrealized d. Percentage of completion method is inappropriate
c. Unrecognized
d. Unalloca ted ANSWER 4-27
1. a 6. b
5. The. term "recognized" is synonymous with the tA=rm 2. C 7. d
a. Recor ded 3. d 8. C
b. Realized 4. h 9. C
c. Matched 5. a
d. AlJocAted

86 87
QUFSTION 4-28 Multiple c hoice (AICPA Adapted)
6. Which of the following should be expensed under th,
l. Cost s thAt can be reasonifiablyroadsusc:i: ~~~;r'~~h spe cific principle of systematic and rational allocation?
revenue but not with spec c P
a. Sa lesmen's monthly salaries
Charged to ex-pense in the period incurred. .
a. All t d to specific products based on the best estunat.e b. Insurance premiums
b. oca e . tun
· c. F reight out
of the product process~g ~-
c. Expen~d in the period m which the related revenue is d. Electricity to light cffice building
recognized. . b
d. Capitalized and then amortized over a reasone le period 7. Which of the following would be matched with current
revenue on a basis other than association of cause and effect'?
2_ Why are certain costs dof doin~ btusdiness capitalizet_
· d when
incurred and then eprec1a e or amor 1ze over a. Goodwill
subsequent accounting periods? b. Sales commission
a. To reduce the income tax liability c. (',ost of goods sold
b. To aid management in the decision-making process d. Purchases on account
c. To match the costs of production with revenue
d. To adhere to the accounting concept of conservatism 8. Which of the following is not a theoretical basis for the
allocation of expense?
3. Which of the following is an example of the expense
recognition principle of associating cause and effect? a. Summarization
a. Allocation of insurance cost b. Classification
b. Sales commissions c. Profit maximization
c. Depreciation of property, plant and equipmen t d. Immediate recognition
d. Officers' salaries
9. What is an example of cost that cannot be directly related lo
4. Which principle best describes the conceptual rationale for particular revenue but incwTed to obtain benefits that are
the method of matching deprer:iation with revenue? exhausr.ed in the period when the cost is incw-red?
a. Associating ca use and effect a. Sales commission
b. Systematic and rational alloca tion h. Sales salary
c. Immediate recognition c. Freight in
d. Partial recognition d. Prepaid insurance

5. Which of the following is an application of the principle of ANSWER 4-28

systematic an<l rational allocation?
l. C 6. b
a. Amortization of inta ngiblP asset ...
? C 7. a
b. Sales commissions 3. b 8. C
c. Re:;earch a nd dew-!lopmen t cost 4. b 9. b
d. Officers' salaries 5. a

88 09
 QUESTION 4-29 Multiple choice (IAA)
6. Whic~ ?at~gory of expenses is subject to immediate
1. The matching principle is best demonstra ted by recogrution m the income statement?
A. Not rccogniz.i ng any expense unless some revenue is a. Utilities expense for the production line of a
manufacturer
rea lized .
b. Associating effort :with accomJ:>lisdhment b. Repairs and maintenance expense incurre d on
c. Recognizing prepaid ren~ r~ce1ve as ~evenue production equipment of a manufacturer
d . Establishing an approprrnt1011 for contmge ncy c. The salary of the production foreman
d. The salary of the president
2. Which accou nting principle is being o bserved ~bvhen an
accountant charges to expense a cost t 1mt contri u ted to 7. "':7hic~ pri_nciple best describes the ratio.nalc for matching
revenue during a period? drntnbut1on costs and admi nistrative expenses with
revenue of the current period?
a. Revenue realization a. DirP.ct matching
b. Matching b. Systematic and rational allocation
c. Monetary unit c. Immediate recognition
d. Conserrntism
d. Partial recognition
3. Which of the following is not an acceptable basis for the
recognition of expense? 8. What is the general approach as t.o when product costs are
recognized as expenses?
a. Systematic and r ationa l allocation
b. Cause and effect association a. In the period when tht:: expenses are paid.
c. Immediate recognition b. In the period when the expenses are jncurred.
d. Cash disbursement c. In the period when the vendor invoice is received.
d.. In the period when the related revenue is recognized.
4. Bad debt expense is recognized according to which expense
recognition principle? 9. When should an expenditure be recorded as an asset rather
than an expense?
a. Direct matching
b. Immediate recognition a. Never
c. Systematic and rational allocation b. Always
d. Critical event recognition c. If the amount is material
d. When future benefit exists
5. An example of direct matching of an ex:penoe with revenue
would be ANSWER 4-29

a. Depreciation expense 1. b 6. d
b. Office salaries expense 2. b 7. C
c. Direct labor cost incur red to produce inventory sold 3. d 8. d
during a period 4. a 9. d
d. Advertising expense 5. C

90 91
QUE STIO N 4~30 Mult iple choic e (A.IC PA Adap ted)

1. A decre ase in asset arisin g from perip heral or incidental

transa ction is called
a. Capit al expen diture
b. Cost
c. Loss
d. Expe nse
2. An outflow of asset based on an activi ty that repre sents the
majo r opera tions is called ·
a. Loss
b. Liabi lity
c. Expe nse
·d. Equit y

3. The prima ry distinction between reven ue and gain is

a. The mater ialitv of the amou nt.
b. The likelih ood that the transa ctic,n will recur in lhe
future .
c. The natur e of the activ ity that gives rise to the
transa ction.
d. The m~tho d of dii;closing the transaction..

4. Whic h state ment in relati on to the term "expe nse" is

incor rect?
a. All expen ses and losses sre expir ed costs but not all
expired costs are expe11ses or losses.
b. All expen_ses decn; ase owne rs' equit y but not all
decre ase s_ 1n owners equity are expen ses.
c. E :Kp_e?s~ 1s synon ymou s with expen ditu1e .
d. Entiti es do not incur expen ses per·se but initia lly acquire
8 f3Sets. '

ANbW ER 4-30
1. C
2. C
3. C
4. C

9l