BA3: Principles

Answer: A. External users are outside the organisation: a bank deciding whether to lend relies on the published financial statements to assess creditworthiness, because it cannot access internal records. The board of directors, the management accountant and a supervisor are all internal users with access to far more detailed internal information. Financial accounting serves external users who depend on the general-purpose financial statements.

Answer: B. The accounting equation states that assets = capital + liabilities, so capital = assets − liabilities = £80,000 − £30,000 = £50,000. The £110,000 figure adds liabilities to assets instead of subtracting them. Capital represents the owner's residual interest in the business after deducting everything it owes. The equation must always balance, which underpins double-entry bookkeeping.

Answer: C. The accruals (matching) concept requires income and the expenses incurred in generating it to be recognised in the same period, regardless of when cash is received or paid. Going concern assumes the business will continue operating, materiality concerns whether an item is significant enough to influence decisions, and prudence concerns not overstating assets or income. Matching costs to the related revenue is the accruals concept.

Answer: A. International Financial Reporting Standards are issued by the International Accounting Standards Board, the independent standard-setting body of the IFRS Foundation. A stock exchange sets listing rules but not accounting standards, a professional body such as CIMA provides qualifications and guidance, and a tax authority administers taxation. The IASB develops the global financial reporting framework that companies applying IFRS must follow.

Answer: B. The going concern assumption holds that the entity will continue in operation for the foreseeable future and has no intention or need to cease trading or curtail its activities. This justifies valuing assets at cost rather than break-up values. The accruals concept matches income and expenses to periods, prudence avoids overstating assets and income, and the business entity concept separates the owner from the business. Going concern is the assumption about continuity.

Answer: C. Capital expenditure is spending on acquiring or improving non-current assets that provide benefit over more than one period — buying a delivery vehicle is a clear example and is capitalised in the statement of financial position. Repairs, wages and rent are revenue expenditure: day-to-day running costs charged in full to the statement of profit or loss in the period incurred. The distinction determines whether an item is an asset or an expense.

Answer: B. Faithful representation requires information to be complete, neutral and free from error, so that it faithfully depicts the economic substance of what it purports to represent. Comparability allows users to identify similarities and differences between items, timeliness concerns having information available in time to influence decisions, and verifiability concerns independent corroboration. Completeness, neutrality and freedom from error together define faithful representation.

Answer: C. General-purpose financial statements exist to provide information about an entity's financial position, performance and cash flows that is useful to a wide range of users in making economic decisions. They are not a tax computation, not a transaction listing, and not a substitute for the internal management accounts that managers use. Serving the decision-making needs of external users is their primary purpose.

Answer: A. The consistency concept requires similar items to be treated the same way in successive periods, so that the financial statements can be compared meaningfully over time. Prudence concerns not overstating assets or income, materiality concerns whether an item is significant, and going concern assumes continued operation. Consistency supports comparability — a change in policy is only made where it gives more relevant or reliable information, and is then disclosed.

Answer: B. Substance over form requires transactions to be accounted for according to their commercial reality, not merely their legal appearance — for example, treating an asset acquired under a finance arrangement as an asset of the business even if legal title has not passed. Historical cost concerns valuation, money measurement limits recording to monetary items, and dual aspect underlies double entry. Faithful representation depends on reflecting economic substance.

Answer: B. Materiality is judged by impact: an item is material if omitting or misstating it could influence the economic decisions users make on the basis of the financial statements. Materiality depends on the size or nature of the item in context, not on its physical size, the type of account, or where it is recorded. The concept allows immaterial items to be treated in the most practical way without distorting the accounts.

Answer: C. The money measurement concept restricts the accounts to items that can be measured reliably in monetary terms, which is why valuable but unmeasurable factors such as staff morale or a skilled workforce are not recognised. It does not require all transactions to be in cash, nor is it about physically counting money or limiting to one currency. The concept defines the boundary of what financial accounting can capture.

Answer: D. The directors are responsible for preparing the financial statements and ensuring they give a true and fair view, as part of their stewardship of the company. The external auditors give an independent opinion on those statements but do not prepare them. Shareholders own the company but delegate management to the directors, and the tax authority assesses tax. Preparation and fair presentation are a directorial responsibility.

Answer: C. The historical cost concept records assets at their original acquisition cost, which is objective and verifiable. Prudence concerns caution in recognising gains and losses, realisation concerns when to recognise profit, and money measurement limits recording to monetary items. Although historical cost can become outdated when prices change, its objectivity is why it remains the usual basis of measurement, subject to specific revaluation rules.

Answer: D. The external auditor's role is to give an independent opinion on whether the financial statements give a true and fair view and comply with the relevant framework. Preparing the statements and setting accounting policies are the directors' responsibilities, and day-to-day management is also the directors'. The auditor adds credibility to the statements for users but does not prepare them, which preserves the auditor's independence.