Problem:
Three independent unrelated paragraphs follow. Each one contains some unsound reasoning. For this practice, identify the areas that are not in accordance with US GAAP or are not true and explain why the reasoning is incorrect. Complete the identification and explanation of each paragraph before proceeding to the next paragraph.
P1: One function of financial accounting is to measure an entity's net income for a given period of time. An income statement prepared in accordance with US GAAP will reflect the true net income. The idea is to match revenues with expenses. Revenues are inflow of cash and should be realized when recognized. Expenses are an outflow of cash and should be recognized when paid. Dividends declared reduce retained earnings, and dividends paid are an expense. Extraordinary items are shown separately at the bottom of the income statement. A good net income is about 5% of revenues for all entities.
P2: One function of financial accounting is to accurately present an entity's financial position at a point in time. The balance sheet is prepared using historical costs for all assets. Assets represent future benefits for the entity. Unearned revenues are assets and prepaid expenses are liabilities. Retained earnings will usually equal cash available for the entity. Goodwill may be set up any time by an entity with an offsetting entry to "equity." "Depreciation" is measured as declining value of certain assets. The term "capitalize" means set up as an asset. WorldCom was accused of allegedly expensing items that should have been capitalized.
P3: Accounting is an exact science because the financial statements, which are not related to each other, have no limitations. US GAAP is established by the FASB, which is part of the US government. International accounting standards are established by the United Nations. All standard setting bodies have been concerned with "off-balance-sheet-reporting," which means that assets are left off the balance sheet. All entities must be audited by an independent CPA, who takes responsibility for these financial statements.
While accounting concepts and tax rules may overlap, they are not necessarily the same.