Wrap-up: Principles

We just covered four underlying principles in accounting:

Historical Cost	Financial statements report companies’ resources and obligations at an initial historical cost. This conservative measure precludes constant appraisal and revaluation.
Revenue Recognition	Revenues must be recorded when earned and measurable.
Matching Principle	Costs of a product must be recorded during the same period as revenue from selling it.
Disclosure	Companies must reveal all relevant economic information determined to make a difference to their users.

Exercise

Q1:

Under GAAP, how should companies record their resources?

Exercise

Q1:

Under the accrual basis of accounting,

	Revenues are recognized when the product or service associated with generating those revenues is delivered/performed.
	Expenses generated in creating a product or service are recognized and reported as they are incurred.
	Expenses generated in creating a product or service are recognized in the same period as revenues from that product or service.
	Revenues are recognized only when cash for a product or service is received.

Exercise

Q1:

A car manufacturer purchases $5,000 in tires (for cash) from a tire plant. When would a tire plant be able to record revenues from this sale?

	As soon as the car manufacturer puts in the $5,000 order
	As soon as those tires are delivered to the car manufacturer
	Over time, as the car manufacturer continues to sell them
	Only when the car manufacturer has used or sold all of those tires

Solution

Q1:

Under GAAP, how should companies record their resources?

	At historical cost
	At fair value [GAAP does not allow companies to revalue resources to their fair market value.]
	At book value [Historical cost is typically called book value.]
	At acquisition cost [Historical and acquisition costs are synonymous.]

Solution

Q1:

Under the accrual basis of accounting,

	Revenues are recognized when the product or service associated with generating those revenues is delivered/performed.
	Expenses generated in creating a product or service are recognized and reported as they are incurred.
	Expenses generated in creating a product or service are recognized in the same period as revenues from that product or service.
	Revenues are recognized only when cash for a product or service is received.

Solution

Q1:

A car manufacturer purchases $5,000 in tires (for cash) from a tire plant. When would a tire plant be able to record revenues from this sale?

	As soon as the car manufacturer puts in the $5,000 order
	As soon as those tires are delivered to the car manufacturer
	Over time, as the car manufacturer continues to sell them
	Only when the car manufacturer has used or sold all of those tires