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Preview of Chapter 1

Financial Accounting
Ninth Edition
Weygandt Kimmel Kieso
1-1

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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What is Accounting?
Accounting consists of three basic activitiesit

identifies,

records, and

communicates

the economic events of an organization to interested users.

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LO 1

What is Accounting?
Three Activities

Illustration 1-1
The activities of the
accounting process

The accounting process includes


the bookkeeping function.

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LO 1

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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Who Uses Accounting Data


Internal
Users

Illustration 1-2
Questions that internal
users ask

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LO 2

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LO 2

Who Uses Accounting Data


External
Users

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Illustration 1-3
Questions that external
users ask

LO 2

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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The Building Blocks of Accounting


Ethics In Financial Reporting
United States regulators and lawmakers were very concerned
that the economy would suffer if investors lost confidence in
corporate accounting because of unethical financial reporting.

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Recent financial scandals include: Enron, WorldCom,


HealthSouth, AIG, and others.

Congress passed Sarbanes-Oxley Act of (SOX).

Effective financial reporting depends on sound ethical


behavior.

LO 3

The Building Blocks of Accounting


Ethics In Financial Reporting

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Illustration 1-4
Steps in analyzing ethics cases
and situations

LO 3

Ethics in Financial Reporting


Question
Ethics are the standards of conduct by which one's actions are
judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.

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LO 3

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LO 3

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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Generally Accepted Accounting Principles


Various users
need financial
information

Financial Statements

The accounting profession


has attempted to develop a
set of standards that are
generally accepted and
universally practiced.

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Balance Sheet
Income Statement
Statement of Stockholders Equity
Statement of Cash Flows
Note Disclosure

Generally Accepted
Accounting
Principles (GAAP)

LO 4

Generally Accepted Accounting Principles


Generally Accepted Accounting Principles (GAAP) Standards
that are generally accepted and universally practiced. These
standards indicate how to report economic events.
Standard-setting bodies:

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Financial Accounting Standards Board


(FASB)

Securities and Exchange Commission


(SEC)

International Accounting Standards


Board (IASB)

LO 4

Generally Accepted Accounting Principles


Measurement Principles
Historical Cost Principle (or cost principle) dictates that
companies record assets at their cost.

Fair Value Principle states that assets and liabilities should


be reported at fair value (the price received to sell an asset or
settle a liability).
Selection of which principle to follow
generally relates to trade-offs
between relevance and faithful
representation.
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LO 4

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LO 4

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity
assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
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[8] Understand the four financial statements and how they are prepared.

Generally Accepted Accounting Principles


Assumptions
Monetary Unit Assumption requires that companies
include in the accounting records only transaction data that can
be expressed in terms of money.

Economic Entity Assumption requires that activities of the


entity be kept separate and distinct from the activities of its owner
and all other economic entities.

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Proprietorship.

Partnership.

Corporation.

Forms of Business
Ownership
LO 5

Forms of Business Ownership


Proprietorship

Generally owned
by one person.

Owned by two or
more persons.

Often small
service-type
businesses

Often retail and


service-type
businesses

Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts.

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Partnership

Generally
unlimited
personal liability

Corporation

Ownership
divided into
shares of stock

Separate legal
entity organized
under state
corporation law

Limited liability

Partnership
agreement
LO 5

Indicate whether each of the following statements presented below


is true or false.

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1.

The three steps in the accounting process are


identification, recording, and communication.

True

2.

The two most common types of external users are


investors and company officers.

False

3.

Congress passed the Sarbanes-Oxley Act to reduce


unethical behavior and decrease the likelihood of
future corporate scandals.

Advance slide in presentation mode to reveal answers.

True

LO 5

Indicate whether each of the following statements presented below


is true or false.
4.

5.

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The primary accounting standard-setting body in the


United States is the Financial Accounting Standards
Board (FASB).

True

The cost principle dictates that companies record


assets at their cost. In later periods, however, the fair
value of the asset must be used if fair value is higher
than its cost.

False

Advance slide in presentation mode to reveal answers.

LO 5

Generally Accepted Accounting Principles


Question
Combining the activities of Kellogg and General Mills would
violate the
a. cost principle.
b. economic entity assumption.
c. monetary unit assumption.
d. ethics principle.

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Advance slide in presentation mode to reveal answers.

LO 5

Generally Accepted Accounting Principles


Question
A business organized as a separate legal entity under state law
having ownership divided into shares of stock is a
a. proprietorship.
b. partnership.
c. corporation.
d. sole proprietorship.

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Advance slide in presentation mode to reveal answers.

LO 5

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LO 5

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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The Basic Accounting Equation


Assets

Liabilities

Stockholders
Equity

Provides the underlying framework for recording and


summarizing economic events.
Assets must equal the sum of liabilities and stockholders
equity.
Claims of creditors (liabilities) must be paid before ownership
claims (stockholders equity).

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LO 6

The Basic Accounting Equation


Assets

Liabilities

Stockholders
Equity

Assets

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Resources a business owns.

Provide future services or benefits.

Cash, Supplies, Equipment, etc.

LO 6

The Basic Accounting Equation


Assets

Liabilities

Stockholders
Equity

Liabilities

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Claims against assets (debts and obligations).

Creditors - party to whom money is owed.

Accounts payable, Notes payable, etc.

LO 6

The Basic Accounting Equation


Assets

Liabilities

Stockholders
Equity

Stockholders Equity

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Ownership claim on total assets.

Referred to as residual equity.

Common stock and retained earnings.

LO 6

The Basic Accounting Equation


Illustration 1-6

Investments by stockholders represent the total amount paid in by


stockholders for the shares they purchase.

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LO 6

The Basic Accounting Equation


Illustration 1-6

Revenues result from business activities entered into for the purpose
of earning income.
Common sources of revenue are: sales, fees, services, commissions,
interest, dividends, royalties, and rent.
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LO 6

The Basic Accounting Equation


Illustration 1-6

Dividends are the distribution of cash or other assets to stockholders.


Dividends reduce retained earnings. However, dividends are not an
expense.

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LO 6

The Basic Accounting Equation


Illustration 1-6

Expenses are the cost of assets consumed or services used in the


process of earning revenue.
Common expenses are: salaries expense, rent expense, utilities
expense, tax expense, etc.
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LO 6

Classify the following items as issuance of stock, dividends,


revenues, or expenses. Then indicate whether each item
increases or decreases stockholders equity.
Classification

Effect on Equity

1. Rent Expense

Expense

Decrease

2. Service Revenue

Revenue

Increase

Equity

Decrease

Expense

Decrease

3. Dividends
4. Salaries and Wages
expense
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Advance slide in presentation mode to reveal answers.

LO 6

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting
equation.
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[8] Understand the four financial statements and how they are prepared.

Using the Accounting Equation


Transactions are a businesss economic events recorded
by accountants.

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May be external or internal.

Not all activities represent transactions.

Each transaction has a dual effect on the accounting


equation.

LO 7

Using the Accounting Equation


Illustration: Are the following events recorded in the accounting
records?
Illustration 1-7

Discuss product
design with
potential customer.

Event

Purchase
computer.

Criterion

Is the financial position (assets, liabilities, or


stockholders equity) of the company changed?

Pay rent.

Record/ Dont
Record

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Advance slide in presentation mode to reveal answers.

LO 7

Using the Accounting Equation


Illustration 1-8
Expanded accounting equation

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LO 7

Transaction Analysis
Transaction (1). Investment by Stockholders. Ray and Barbara
Neal decides to open a computer programming service which he
names Softbyte. On September 1, 2015, they invest $15,000 cash
in exchange for common stock.

Illustration 1-9

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Advance slide in presentation mode to reveal answers.

LO 7

Transaction Analysis
Transaction (2). Purchase of Equipment for Cash. Softbyte
purchases computer equipment for $7,000 cash.

Illustration 1-9

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LO 7

Transaction Analysis
Transaction (3). Purchase of Supplies on Credit. Softbyte
purchases for $1,600 from Acme Supply Company computer paper
and other supplies expected to last several months.
Illustration 1-9

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LO 7

Transaction Analysis
Transaction (4). Services Provided for Cash. Softbyte receives
$1,200 cash from customers for programming services it has
provided.
Illustration 1-9

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LO 7

Transaction Analysis
Transaction (5). Purchase of Advertising on Credit. Softbyte
receives a bill for $250 from the Daily News for advertising but
postpones payment until a later date.
Illustration 1-9

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LO 7

Transaction Analysis
Transaction (6). Services Provided for Cash and Credit. Softbyte
provides $3,500 of programming services for customers. The
company receives cash of $1,500 from customers, and it bills the
balance of $2,000 on account.

Illustration 1-9

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LO 7

Transaction Analysis
Transaction (7). Payment of Expenses. Softbyte pays the
following expenses in cash for September: store rent $600, salaries
and wages of employees $900, and utilities $200.
Illustration 1-9

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LO 7

Transaction Analysis
Transaction (8). Payment of Accounts Payable. Softbyte pays its
$250 Daily News bill in cash.

Illustration 1-9

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LO 7

Transaction Analysis
Transaction (9). Receipt of Cash on Account. Softbyte receives
$600 in cash from customers who had been billed for services [in
Transaction (6)].
Illustration 1-9

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LO 7

Transaction Analysis
Transaction (10). Dividends. The corporation pays a dividend of
$1,300 in cash.

Illustration 1-9

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LO 7

Accounting in Action

Accounting in Action

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain what accounting is.
[2] Identify the users and uses of accounting.
[3] Understand why ethics is a fundamental business concept.
[4] Explain generally accepted accounting principles.
[5] Explain the monetary unit assumption and the economic entity assumption.
[6] State the accounting equation, and define its components.
[7] Analyze the effects of business transactions on the accounting equation.
[8] Understand the four financial statements and how they are prepared.
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Financial Statements
Companies prepare four financial statements :

Income
Statement

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Retained
Earnings
Statement

Balance
Sheet

Statement
of Cash
Flows

LO 8

Financial Statements
Question
Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.

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Advance slide in presentation mode to reveal answers.

LO 8

Financial Statements

Net income is needed to determine the


ending balance in retained earnings.

Illustration 1-10
Financial statements and
their interrelationships

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LO 8

Financial Statements

The ending balance in retained earnings


is needed in preparing the balance sheet.

Illustration 1-10

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LO 8

Financial Statements

Balance sheet and income statement are


needed to prepare statement of cash flows.

Illustration 1-10

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LO 8

Financial Statements
Income Statement

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Reports the profitability of the companys operations over


a specific period of time.

Lists revenues first, followed by expenses.

Shows net income (or net loss).

LO 8

Financial Statements
Retained Earnings Statement

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Reports the changes in retained earnings for a specific


period of time.

The time period is the same as that covered by the


income statement.

LO 8

Financial Statements
Balance Sheet

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Reports the assets, liabilities, and stockholders equity at


a specific date.

Lists assets at the top, followed by liabilities and


stockholders equity.

Total assets must equal total liabilities and stockholders


equity.

Is a snapshot of the companys financial condition at a


specific moment in time (usually the month-end or yearend).
LO 8

Financial Statements
Statement of Cash Flows

Information on the cash receipts and


payments for a specific period of time.

Answers the following:


1. Where did cash come from?
2. What was cash used for?
3. What was the change in the
cash balance?

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LO 8

Financial Statements
Question
Which of the following financial statements is prepared as
of a specific date?
a. Balance sheet.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.

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LO 8

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LO 8

APPENDIX 1A

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Accounting Career Opportunities

Public Accounting

Private Accounting

Careers in auditing, taxation,


and management consulting
serving the general public.

Careers in industry working in


cost accounting, budgeting,
accounting information
systems, and taxation.

Governmental Accounting

Forensic Accounting

Careers with the IRS, the FBI,


the SEC, and in public
colleges and universities.

Uses accounting, auditing, and


investigative skills to conduct
investigations into theft and
fraud.

LO 9 Explain the career opportunities in accounting.

APPENDIX 1A

Accounting Career Opportunities

Show Me the Money


Salary estimates for jobs in public and corporate accounting

Illustration 1A-1

Upper-level management salaries in corporate accounting

Illustration 1A-2

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LO 9

Key Points

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International standards are referred to as International Financial


Reporting Standards (IFRS), developed by the International
Accounting Standards Board (IASB).

Much of the world has voted for the standards issued by the IASB.
Over 115 countries require or permit use of IFRS.

The fact that there are differences between what is in this textbook
(which is based on U.S. standards) and IFRS should not be surprising
because the FASB and IASB have responded to different user needs.

LO 10

Key Points

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Debate about international companies (non-U.S.) adopting SOX-type


standards centers on whether the benefits exceed the costs. The
concern is that the higher costs of SOX compliance are making the
U.S. securities markets less competitive.

The textbook mentions a number of ethics violations, such as Enron,


WorldCom, and AIG. These problems have also occurred
internationally, for example, at Satyam Computer Services (India),
Parmalat (Italy), and Royal Ahold (the Netherlands).

LO 10

Key Points

1-67

IFRS tends to be simpler in its accounting and disclosure


requirements; some people say more principles-based. GAAP is
more detailed; some people say it is more rules-based.

U.S. regulators have recently eliminated the need for foreign


companies that trade shares in U.S. markets to reconcile their
accounting with GAAP.

Because the choice of business organization is influenced by factors


such as legal environment, tax rates and regulations, and degree of
entrepreneurism, the relative use of each form will vary across
countries.

The conceptual framework that underlies IFRS is very similar to that


used to develop GAAP.
LO 10

Key Points

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The more substantive definitions, using the IASB definitional


structure, are as follows.

Assets. A resource controlled by the entity as a result of past


events and from which future economic benefits are expected to
flow to the entity.

Liabilities. A present obligation of the entity arising from past


events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits. Liabilities may be legally enforceable via a contract or
law, but need not be, i.e., they can arise due to normal business
practice or customs.

LO 10

Key Points

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The more substantive definitions, using the IASB definitional


structure, are as follows.

Equity. A residual interest in the assets of the entity after


deducting all its liabilities.

Income. Increases in economic benefits that result in increases


in equity (other than those related to contributions from
shareholders). Income includes both revenues (resulting from
ordinary activities) and gains.

Expenses. Decreases in economic benefits that result in


decreases in equity (other than those related to distributions to
shareholders). Expenses includes losses that are not the result
of ordinary activities.
LO 10

Looking to the Future


Both the IASB and the FASB are hard at work developing standards that will
lead to the elimination of major differences in the way certain transactions
are accounted for and reported. In fact, at one time the IASB stated that no
new major standards would become effective until 2011. The major reason
for this policy was to provide companies the time to translate and implement
IFRS into practice, as much has happened in a very short period of time.

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LO 10

A Look at IFRS
IFRS Practice
Which of the following is not a reason why a single set of high-quality
international accounting standards would be beneficial?
a) Mergers and acquisition activity.
b) Financial markets.
c) Multinational corporations.
d) GAAP is widely considered to be a superior reporting system.

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LO 10

A Look at IFRS
IFRS Practice
The Sarbanes-Oxley Act determines:
a) international tax regulations.
b) internal control standards as enforced by the IASB.
c) internal control standards of U.S. publicly traded companies.
d) U.S. tax regulations.

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LO 10

A Look at IFRS
IFRS Practice
IFRS is considered to be more:
a) principles-based and less rules-based than GAAP.
b) rules-based and less principles-based than GAAP.
c) detailed than GAAP.
d) None of the above.

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LO 10

Copyright
Copyright 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may
make back-up copies for his/her own use only and not for distribution
or resale. The Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these programs or from
the use of the information contained herein.

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