ACCA Financial Reporting (F7) Practice Exam

What is one of the two underlying assumptions of financial statements?

1. Historical Cost

2. Accrual Basis

3. Cash Basis

4. Materiality

The correct answer is: Accrual Basis

The accrual basis is one of the fundamental underlying assumptions of financial statements and plays a crucial role in financial reporting. Under the accrual basis, transactions and events are recognized in the financial statements when they occur, regardless of when cash flows related to them are received or paid. This means that income is recognized when earned, and expenses are recognized when incurred, providing a more accurate reflection of a company's financial position and performance during a specific period. This approach allows users of the financial statements to gain a clearer understanding of the company’s actual economic activities, as it matches revenues with the expenses incurred in generating them. This principle is essential for providing a complete and fair view of the financial state of the business, aligning with the consistency and transparency objectives of accounting standards. In contrast, the other options include concepts like historical cost and cash basis, which are not underlying assumptions. Historical cost refers to the valuation of assets and liabilities based on the original transaction prices, while cash basis accounting recognizes revenues and expenses only when cash is actually received or paid. Although these concepts are relevant in financial reporting, they do not represent the foundational assumption for the preparation of financial statements like the accrual basis does. Materiality, on the other hand, relates to the significance of transactions and