Which of the following statements is correct regarding the legality and enforceability of contracts in the context of financial accounting?

• A. Verbal agreements are always recognized in financial accounting, even if not legally binding.
• B. Only transactions supported by legally enforceable contracts are recognized in financial accounting.
• C. Financial accounting does not require any form of contract for transaction recognition.
• D. Financial accounting records all agreements, regardless of their legal enforceability.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the context of the question. The problem is asking about the relationship between contracts and their recognition in financial accounting. Specifically, it focuses on whether financial accounting recognizes transactions based on their legal enforceability.
2. Step 2: Clarify the concept of transaction recognition in financial accounting. Financial accounting primarily records transactions that have economic substance and are supported by evidence, such as legally enforceable contracts. This ensures the reliability and accuracy of financial statements.
3. Step 3: Evaluate the options provided in the question. Analyze each statement to determine its alignment with the principles of financial accounting. For example, verbal agreements may not always be legally binding, and financial accounting typically requires legally enforceable contracts for recognition.
4. Step 4: Identify the correct principle. Financial accounting recognizes transactions that are supported by legally enforceable contracts because these provide a clear basis for recording and reporting financial information.
5. Step 5: Conclude that the correct answer is: 'Only transactions supported by legally enforceable contracts are recognized in financial accounting.' This aligns with the principle of reliability and legal enforceability in financial accounting.