Question

1.What are the four basic assumptions underlying GAAP?

2.Briefly define the financial accounting elements: (1) assets, (2) liabilities, (3) equity, (4) investments by owners, (5) distributions to owners, (6) revenues, (7) expenses, (8) gains, (9) losses, (10) comprehensive income.

Answer 1

1) Four basic assumptions underlying GAAP

1- Economic Entity Assumption:- It states that the enterprise is separate from its owners and other entities. Every economic entity can be separately identified and accounted for. Only the transactions related to the entity are recorded in the journal

2- Going Concern Assumption;- The entity will remain in existence for a forseeable future. It is assumed that the enterprise has no intention to discontinue its operation.

3- Periodicity Assumption;- It is assumed that the economic life of an enterprise is split into periodic intervals which are known as accounting periods.

4- Monetory Unit Assumption;- Only those events that can be expressed in money are included in the accounting records

2) Definitions

Assets- Resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

Liabilities- Present obligation of the entity arising from past events and the settlement of which is expected to result in an outflow from the entity.

Equity- Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Investments by owners- Simply it is the amount of assets owner brings into the company. Investment property is the property held to earn rentals or capital gains or both.

Distributions to owners- It is a payment of retained earnings by the business to its owners. This distribution reduces the assets and equity of the business. This distribution is usually made in cash, though it can also made by using other assets of the company.

Revenue- It is the gross inflow of economic benefits during the period, arising from the course of the ordinary activities of an entity.

Expenses- It is the decrease in economic benefits during the accounting period in the form of outflows or depletion of assets or incurrences of liabilities that result in decreases in equity.

Gains- Gain is the excess of revenue over cost for a transaction outside the normal course of business.

Losses- Loss occurs when cost exceeds revenue for a transaction outside the normal course of business.

Comprehensive income- It is the changes in equity of a business during a period from non-owner sources.