1460T c02.gxd 11:11:2005 09:45 Page 48 Nishant-16 NIshant-16:Desktop polder:prakash 11/11: EQA 48 Chapter 2 Conceptual Framework Underlying Financial Accounting QUESTIONS 1.What is a conceptual framework?Why is a conceptual 14.When is revenue generally recognized?Why has that framework necessary in financial accounting? date been chosen as the point at which to recognize the 2.What are the primary objectives of financial reporting revenue resulting from the entire producing and selling as indicated in Statement of Financial Accounting Concepts process? No.1? 15.Magnus Eatery operates a catering service specializing 3.What is meant by the term "qualitative characteristics of in business luncheons for large corporations.Magnus accounting information"? requires customers to place their orders 2 weeks in 4.Briefly describe the two primary qualities of useful ac- advance of the scheduled events.Magnus bills its counting information. customers on the tenth day of the month following the 5.According to the FASB conceptual framework,the date of service and requires that payment be made within 30 days of the billing date.Conceptually,when objectives of financial reporting for business enterprises should Magnus recognize revenue related to its cater- are based on the needs of the users of financial state- ing service? ments.Explain the level of sophistication that the Board assumes about the users of financial statements. 16.What is the difference between realized and realizable? Give an example of where the concept of realizable is 6.What is the distinction between comparability and used to recognize revenue. consistency？ 17.What is the justification for the following deviations from 7.Why is it necessary to develop a definitional framework recognizing revenue at the time of sale? for the basic elements of accounting? (a)Installment sales method of recognizing revenue. 8.Expenses,losses,and distributions to owners are all de- creases in net assets.What are the distinctions among (b)Recognition of revenue at completion of production them? for certain agricultural products. 9.Revenues,gains,and investments by owners are all in- (c)The percentage-of-completion basis in long-term creases in net assets.What are the distinctions among construction contracts. them? 18.Jane Hull Company paid $135,000 for a machine in 2007. 10.What are the four basic assumptions that underlie the fi- The Accumulated Depreciation account has a balance of nancial accounting structure? $46,500 at the present time.The company could sell the machine today for $150,000.The company president be- 11.The life of a business is divided into specific time periods, lieves that the company has a "right to this gain."What usually a year,to measure results of operations for each does the president mean by this statement?Do you such time period and to portray financial conditions at agree? the end of each period. 19.Three expense recognition methods (associating cause (a)This practice is based on the accounting assumption and effect,systematic and rational allocation,and im- that the life of the business consists of a series of mediate recognition)were discussed in the text under time periods and that it is possible to measure the matching principle.Indicate the basic nature of each accurately the results of operations for each period. of these types of expenses and give two examples of each. Comment on the validity and necessity of this assumption. 20.Statement of Financial Accounting Concepts No.5identifies four characteristics that an item must have before it is (b)What has been the effect of this practice on account- recognized in the financial statements.What are these ing?What is its relation to the accrual system?What four characteristics? influence has it had on accounting entries and methodology? 21.Briefly describe the types of information concerning financial position,income,and cash flows that might be 12.What is the basic accounting problem created by the provided:(a)within the main body of the financial state- monetary unit assumption when there is significant in- ments,(b)in the notes to the financial statements,or flation?What appears to be the FASB position on a sta- (c)as supplementary information. ble monetary unit? 22.In January 2008,Alan Jackson Inc.doubled the amount 13.The chairman of the board of directors of the company of its outstanding stock by selling on the market an ad- for which you are chief accountant has told you that he ditional 10,000 shares to finance an expansion of the busi- has little use for accounting figures based on cost.He be- ness.You propose that this information be shown by a lieves that replacement values are of far more signifi- footnote on the balance sheet as of December 31,2007. cance to the board of directors than "out-of-date costs." The president objects,claiming that this sale took place Present some arguments to convince him that account- after December 31,2007,and,therefore,should not be ing data should still be based on cost. shown.Explain your position
48 • Chapter 2 Conceptual Framework Underlying Financial Accounting 1. What is a conceptual framework? Why is a conceptual framework necessary in financial accounting? 2. What are the primary objectives of financial reporting as indicated in Statement of Financial Accounting Concepts No. 1? 3. What is meant by the term “qualitative characteristics of accounting information”? 4. Briefly describe the two primary qualities of useful accounting information. 5. According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements. 6. What is the distinction between comparability and consistency? 7. Why is it necessary to develop a definitional framework for the basic elements of accounting? 8. Expenses, losses, and distributions to owners are all decreases in net assets. What are the distinctions among them? 9. Revenues, gains, and investments by owners are all increases in net assets. What are the distinctions among them? 10. What are the four basic assumptions that underlie the financial accounting structure? 11. The life of a business is divided into specific time periods, usually a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period. (a) This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption. (b) What has been the effect of this practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology? 12. What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit? 13. The chairman of the board of directors of the company for which you are chief accountant has told you that he has little use for accounting figures based on cost. He believes that replacement values are of far more significance to the board of directors than “out-of-date costs.” Present some arguments to convince him that accounting data should still be based on cost. 14. When is revenue generally recognized? Why has that date been chosen as the point at which to recognize the revenue resulting from the entire producing and selling process? 15. Magnus Eatery operates a catering service specializing in business luncheons for large corporations. Magnus requires customers to place their orders 2 weeks in advance of the scheduled events. Magnus bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, when should Magnus recognize revenue related to its catering service? 16. What is the difference between realized and realizable? Give an example of where the concept of realizable is used to recognize revenue. 17. What is the justification for the following deviations from recognizing revenue at the time of sale? (a) Installment sales method of recognizing revenue. (b) Recognition of revenue at completion of production for certain agricultural products. (c) The percentage-of-completion basis in long-term construction contracts. 18. Jane Hull Company paid $135,000 for a machine in 2007. The Accumulated Depreciation account has a balance of $46,500 at the present time. The company could sell the machine today for $150,000. The company president believes that the company has a “right to this gain.” What does the president mean by this statement? Do you agree? 19. Three expense recognition methods (associating cause and effect, systematic and rational allocation, and immediate recognition) were discussed in the text under the matching principle. Indicate the basic nature of each of these types of expenses and give two examples of each. 20. Statement of Financial Accounting Concepts No. 5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics? 21. Briefly describe the types of information concerning financial position, income, and cash flows that might be provided: (a) within the main body of the financial statements, (b) in the notes to the financial statements, or (c) as supplementary information. 22. In January 2008, Alan Jackson Inc. doubled the amount of its outstanding stock by selling on the market an additional 10,000 shares to finance an expansion of the business. You propose that this information be shown by a footnote on the balance sheet as of December 31, 2007. The president objects, claiming that this sale took place after December 31, 2007, and, therefore, should not be shown. Explain your position. QUESTIONS 1460T_c02.qxd 11:11:2005 09:45 Page 48 Nishant-16 NIshant-16:Desktop Folder:prakash 11/11:
1460T_c02.qxd12/31/0509:10 am Page49 EQA Brief Exercises·49 23.Describe the two major constraints inherent in the pres- costs incurred from this year's sales should be en- entation of accounting information. tered as an expense this year instead of an expense 24.What are some of the costs of providing accounting in- in the period in the future when the warranty is made formation?What are some of the benefits of accounting good. information?Describe the cost-benefit factors that (b)When sales are made on account,there is always should be considered when new accounting standards uncertainty about whether the accounts are col- are being proposed. lectible.Therefore,the treasurer recommends record- 25.How are materiality (and immateriality)related to the ing the sale when the cash is received from the proper presentation of financial statements?What fac- customers. tors and measures should be considered in assessing the (c)A personal liability lawsuit is pending against the materiality of a misstatement in the presentation of a fi- company.The treasurer believes there is an even nancial statement? chance that the company will lose the suit and have 26.The treasurer of Joan Osborne Co.has heard that con- to pay damages of $200,000 to $300,000.The treas- servatism is a doctrine that is followed in accounting urer recommends that a loss be recorded and a lia- and,therefore,proposes that several policies be followed bility created in the amount of $300,000. that are conservative in nature.State your opinion with (d)The inventory should be valued at "cost or market, respect to each of the policies listed below. whichever is lower"because the losses from price (a)The company gives a 2-year warranty to its cus- declines should be recognized in the accounts in the tomers on all products sold.The estimated warranty period in which the price decline takes place. BRIEF EXERCISES (L0 4)BE2-1 Discuss whether the changes described in each of the cases below require recognition in the CPA's audit report as to consistency.(Assume that the amounts are material.) (a)The company changed its inventory method to FIFO from weighted-average,which had been used in prior years. (b)The company disposed of one of the two subsidiaries that had been included in its consolidated statements for prior years. (c)The estimated remaining useful life of plant property was reduced because of obsolescence. (d)The company is using an inventory valuation method that is different from those used by all other companies in its industry. (L0 4)BE2-2 Identify which qualitative characteristic of accounting information is best described in each item below.(Do not use relevance and reliability.) (a)The annual reports of Best Buy Co.are audited by certified public accountants. (b)Black Decker and Cannondale Corporation both use the FIFO cost flow assumption. (c)Starbucks Corporation has used straight-line depreciation since it began operations. (d)Motorola issues its quarterly reports immediately after each quarter ends. (L0 5)BE2-3 For each item below,indicate to which category of elements of financial statements it belongs (a)Retained earnings (e)Depreciation (h)Dividends (b)Sales (f)Loss on sale of equipment (i)Gain on sale of investment (c)Additional paid-in capital (g)Interest payable (j)Issuance of common stock (d)Inventory (L0 6)BE2-4 Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b)Solectron Corporation,Inc.does not adjust amounts in its financial statements for the effects of inflation. (c)Walgreen Co.reports current and noncurrent classifications in its balance sheet. (d)The economic activities of General Electric and its subsidiaries are merged for accounting and re- porting purposes
23. Describe the two major constraints inherent in the presentation of accounting information. 24. What are some of the costs of providing accounting information? What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed. 25. How are materiality (and immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement? 26. The treasurer of Joan Osborne Co. has heard that conservatism is a doctrine that is followed in accounting and, therefore, proposes that several policies be followed that are conservative in nature. State your opinion with respect to each of the policies listed below. (a) The company gives a 2-year warranty to its customers on all products sold. The estimated warranty costs incurred from this year’s sales should be entered as an expense this year instead of an expense in the period in the future when the warranty is made good. (b) When sales are made on account, there is always uncertainty about whether the accounts are collectible. Therefore, the treasurer recommends recording the sale when the cash is received from the customers. (c) A personal liability lawsuit is pending against the company. The treasurer believes there is an even chance that the company will lose the suit and have to pay damages of $200,000 to $300,000. The treasurer recommends that a loss be recorded and a liability created in the amount of $300,000. (d) The inventory should be valued at “cost or market, whichever is lower” because the losses from price declines should be recognized in the accounts in the period in which the price decline takes place. Brief Exercises • 49 BRIEF EXERCISES BE2-1 Discuss whether the changes described in each of the cases below require recognition in the CPA’s audit report as to consistency. (Assume that the amounts are material.) (a) The company changed its inventory method to FIFO from weighted-average, which had been used in prior years. (b) The company disposed of one of the two subsidiaries that had been included in its consolidated statements for prior years. (c) The estimated remaining useful life of plant property was reduced because of obsolescence. (d) The company is using an inventory valuation method that is different from those used by all other companies in its industry. BE2-2 Identify which qualitative characteristic of accounting information is best described in each item below. (Do not use relevance and reliability.) (a) The annual reports of Best Buy Co. are audited by certified public accountants. (b) Black & Decker and Cannondale Corporation both use the FIFO cost flow assumption. (c) Starbucks Corporation has used straight-line depreciation since it began operations. (d) Motorola issues its quarterly reports immediately after each quarter ends. BE2-3 For each item below, indicate to which category of elements of financial statements it belongs. (a) Retained earnings (e) Depreciation (h) Dividends (b) Sales (f) Loss on sale of equipment (i) Gain on sale of investment (c) Additional paid-in capital (g) Interest payable (j) Issuance of common stock (d) Inventory BE2-4 Identify which basic assumption of accounting is best described in each item below. (a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports. (b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation. (c) Walgreen Co. reports current and noncurrent classifications in its balance sheet. (d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes. (L0 4) (L0 4) (L0 5) (L0 6) 1460T_c02.qxd 12/31/05 09:10 am Page 49
1460T_c02.qxd 11:11:2005 09:45 Page 50 Nishant-16 NIshant-16:Desktop Folder:prakash 11/11: EQA 50.Chapter 2 Conceptual Framework Underlying Financial Accounting (L0 7)BE2-5 Identify which basic principle of accounting is best described in each item below. (a)Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b)Yahoo,Inc.recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c)Oracle Corporation reports information about pending lawsuits in the notes to its financial state- ments. (d)Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it,even though the estimated fair market value is greater. (LO 8)BE2-6 What accounting constraints are illustrated by the items below? (a)Zip's Farms,Inc.reports agricultural crops on its balance sheet at market value. (b)Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (c)Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to financial statement users exceeds the expense of gath- ering it. (d)Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. (LO 8)BE2-7 Presented below are three different transactions related to materiality.Explain whether you would classify these transactions as material. (a)Marcus Co.has reported a positive trend in earnings over the last 3 years.In the current year,it reduces its bad debt allowance to ensure another positive earnings year.The impact of this ad- justment is equal to 3%of net income. (b)Sosa Co.has an extraordinary gain of $3.1 million on the sale of plant assets and a $3.3 million loss on the sale of investments.It decides to net the gain and loss because the net effect is con- sidered immaterial.Sosa Co.'s income for the current year was $10 million. (c)Seliz Co.expenses all capital equipment under $25,000 on the basis that it is immaterial.The com- pany has followed this practice for a number of years. ⊕ (LO 6)BE2-8 If the going concern assumption is not made in accounting,discuss the differences in the amounts shown in the financial statements for the following items. (a)Land. (b)Unamortized bond premium. (c)Depreciation expense on equipment. (d)Merchandise inventory. (e)Prepaid insurance. (L0 6,BE2-9 What accounting assumption,principle,or modifying convention does Target Corporation use 7,8)in each of the situations below? (a)Target uses the lower of cost or market basis to value inventories. (b)Target was involved in litigation over the last year.This litigation is disclosed in the financial state- ments. (c)Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets. (d)Target records the purchase of a new Dell PC at its cash equivalent price. (L0 5)BE2-10 Explain how you would decide whether to record each of the following expenditures as an as- set or an expense.Assume all items are material. (a)Legal fees paid in connection with the purchase of land are $1,500. (b)Benjamin Bratt,Inc.paves the driveway leading to the office building at a cost of $21,000. (c)A meat market purchases a meat-grinding machine at a cost of $3,500. (d)On June 30,Alan and Alda,medical doctors,pay 6 months'office rent to cover the month of July and the next 5 months. (e)Tim Taylor's Hardware Company pays $9,000 in wages to laborers for construction on a building to be used in the business. (f)Nancy Kwan's Florists pays wages of $2,100 for November to an employee who serves as driver of their delivery truck
BE2-5 Identify which basic principle of accounting is best described in each item below. (a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected. (b) Yahoo, Inc. recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue. (c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements. (d) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater. BE2-6 What accounting constraints are illustrated by the items below? (a) Zip’s Farms, Inc. reports agricultural crops on its balance sheet at market value. (b) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000. (c) Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to financial statement users exceeds the expense of gathering it. (d) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired. BE2-7 Presented below are three different transactions related to materiality. Explain whether you would classify these transactions as material. (a) Marcus Co. has reported a positive trend in earnings over the last 3 years. In the current year, it reduces its bad debt allowance to ensure another positive earnings year. The impact of this adjustment is equal to 3% of net income. (b) Sosa Co. has an extraordinary gain of $3.1 million on the sale of plant assets and a $3.3 million loss on the sale of investments. It decides to net the gain and loss because the net effect is considered immaterial. Sosa Co.’s income for the current year was $10 million. (c) Seliz Co. expenses all capital equipment under $25,000 on the basis that it is immaterial. The company has followed this practice for a number of years. BE2-8 If the going concern assumption is not made in accounting, discuss the differences in the amounts shown in the financial statements for the following items. (a) Land. (b) Unamortized bond premium. (c) Depreciation expense on equipment. (d) Merchandise inventory. (e) Prepaid insurance. BE2-9 What accounting assumption, principle, or modifying convention does Target Corporation use in each of the situations below? (a) Target uses the lower of cost or market basis to value inventories. (b) Target was involved in litigation over the last year. This litigation is disclosed in the financial statements. (c) Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets. (d) Target records the purchase of a new Dell PC at its cash equivalent price. BE2-10 Explain how you would decide whether to record each of the following expenditures as an asset or an expense. Assume all items are material. (a) Legal fees paid in connection with the purchase of land are $1,500. (b) Benjamin Bratt, Inc. paves the driveway leading to the office building at a cost of $21,000. (c) A meat market purchases a meat-grinding machine at a cost of $3,500. (d) On June 30, Alan and Alda, medical doctors, pay 6 months’ office rent to cover the month of July and the next 5 months. (e) Tim Taylor’s Hardware Company pays $9,000 in wages to laborers for construction on a building to be used in the business. (f) Nancy Kwan’s Florists pays wages of $2,100 for November to an employee who serves as driver of their delivery truck. 50 • Chapter 2 Conceptual Framework Underlying Financial Accounting (L0 7) (L0 8) (L0 8) (L0 6) (L0 5) (L0 6, 7, 8) 1460T_c02.qxd 11:11:2005 09:45 Page 50 Nishant-16 NIshant-16:Desktop Folder:prakash 11/11:
1460T_c02.qxd 11:11:2005 09:45 Page 51Nishant-16 NIshant-16:Desktop:prakash 11/11: EQA Exercises·51 EXERCISES s (L04, E2-1 (Qualitative Characteristics)SFAC No.2 identifies the qualitative characteristics that make ac- 8) counting information useful.Presented below are a number of questions related to these qualitative char- acteristics and underlying constraints. (a)What is the quality of information that enables users to confirm or correct prior expectations? (b)Identify the two overall or pervasive constraints developed in SFAC No.2. (c) The chairman of the SEC at one time noted,"If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic meas- urement,we assume a grave risk that confidence in the credibility of our financial information system will be undermined."Which qualitative characteristic of accounting information should ensure that such a situation will not occur?(Do not use reliability.) (d)Billy Owens Corp.switches from FIFO to average cost to FIFO over a 2-year period.Which qual- itative characteristic of accounting information is not followed? (e)Assume that the profession permits the savings and loan industry to defer losses on investments it sells,because immediate recognition of the loss may have adverse economic consequences on the industry.Which qualitative characteristic of accounting information is not followed?(Do not use relevance or reliability.) (f)What are the two primary qualities that make accounting information useful for decision making? (g) Rex Chapman,Inc.does not issue its first-quarter report until after the second quarter's results are reported.Which qualitative characteristic of accounting is not followed?(Do not use rele- vance.) (h)Predictive value is an ingredient of which of the two primary qualities that make accounting in- formation useful for decision-making purposes? ( Ronald Coles,Inc.is the only company in its industry to depreciate its plant assets on a straight- line basis.Which qualitative characteristic of accounting information may not be followed?(Do not use industry practices.) (GjD Jeff Malone Company has attempted to determine the replacement cost of its inventory.Three different appraisers arrive at substantially different amounts for this value.The president,never- theless,decides to report the middle value for external reporting purposes.Which qualitative characteristic of information is lacking in these data?(Do not use reliability or representational faithfulness.) (L0 4)E2-2 (Qualitative Characteristics)The qualitative characteristics that make accounting information useful for decision-making purposes are as follows. Relevance Timeliness Representational faithfulness Reliability Verifiability Comparability Predictive value Neutrality Consistency Feedback value Instructions Identify the appropriate qualitative characteristic(s)to be used given the information provided below. (a) Qualitative characteristic being employed when companies in the same industry are using the same accounting principles. (b)Quality of information that confirms users'earlier expectations. (c) Imperative for providing comparisons of a company from period to period (d)Ignores the economic consequences of a standard or rule. (e) Requires a high degree of consensus among individuals on a given measurement. () Predictive value is an ingredient of this primary quality of information. (g) Two qualitative characteristics that are related to both relevance and reliability. (h)Neutrality is an ingredient of this primary quality of accounting information. () Two primary qualities that make accounting information useful for decision-making purposes p Issuance of interim reports is an example of what primary ingredient of relevance? (LO 5)E2-3 (Elements of Financial Statements)Ten interrelated elements that are most directly related to measuring the performance and financial status of an enterprise are provided below. Assets Distributions to owners Expenses Liabilities Comprehensive income Gains Equity Revenues Losses Investments by owners
EXERCISES E2-1 (Qualitative Characteristics) SFAC No. 2 identifies the qualitative characteristics that make accounting information useful. Presented below are a number of questions related to these qualitative characteristics and underlying constraints. (a) What is the quality of information that enables users to confirm or correct prior expectations? (b) Identify the two overall or pervasive constraints developed in SFAC No. 2. (c) The chairman of the SEC at one time noted, “If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement, we assume a grave risk that confidence in the credibility of our financial information system will be undermined.” Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use reliability.) (d) Billy Owens Corp. switches from FIFO to average cost to FIFO over a 2-year period. Which qualitative characteristic of accounting information is not followed? (e) Assume that the profession permits the savings and loan industry to defer losses on investments it sells, because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed? (Do not use relevance or reliability.) (f) What are the two primary qualities that make accounting information useful for decision making? (g) Rex Chapman, Inc. does not issue its first-quarter report until after the second quarter’s results are reported. Which qualitative characteristic of accounting is not followed? (Do not use relevance.) (h) Predictive value is an ingredient of which of the two primary qualities that make accounting information useful for decision-making purposes? (i) Ronald Coles, Inc. is the only company in its industry to depreciate its plant assets on a straightline basis. Which qualitative characteristic of accounting information may not be followed? (Do not use industry practices.) (j) Jeff Malone Company has attempted to determine the replacement cost of its inventory. Three different appraisers arrive at substantially different amounts for this value. The president, nevertheless, decides to report the middle value for external reporting purposes. Which qualitative characteristic of information is lacking in these data? (Do not use reliability or representational faithfulness.) E2-2 (Qualitative Characteristics) The qualitative characteristics that make accounting information useful for decision-making purposes are as follows. Relevance Timeliness Representational faithfulness Reliability Verifiability Comparability Predictive value Neutrality Consistency Feedback value Instructions Identify the appropriate qualitative characteristic(s) to be used given the information provided below. (a) Qualitative characteristic being employed when companies in the same industry are using the same accounting principles. (b) Quality of information that confirms users’ earlier expectations. (c) Imperative for providing comparisons of a company from period to period. (d) Ignores the economic consequences of a standard or rule. (e) Requires a high degree of consensus among individuals on a given measurement. (f) Predictive value is an ingredient of this primary quality of information. (g) Two qualitative characteristics that are related to both relevance and reliability. (h) Neutrality is an ingredient of this primary quality of accounting information. (i) Two primary qualities that make accounting information useful for decision-making purposes. (j) Issuance of interim reports is an example of what primary ingredient of relevance? E2-3 (Elements of Financial Statements) Ten interrelated elements that are most directly related to measuring the performance and financial status of an enterprise are provided below. Assets Distributions to owners Expenses Liabilities Comprehensive income Gains Equity Revenues Losses Investments by owners Exercises • 51 (L0 4, 8) (L0 4) (L0 5) 1460T_c02.qxd 11:11:2005 09:45 Page 51 Nishant-16 NIshant-16:Desktop Folder:prakash 11/11:
1460T_c02.qxd12/31/0509:10 am Page52 EQA 52 Chapter 2 Conceptual Framework Underlying Financial Accounting Instructions Identify the element or elements from page 51 associated with the 12 items below. (a)Arises from peripheral or incidental transactions. (b)Obligation to transfer resources arising from a past transaction. (c)Increases ownership interest. (d)Declares and pays cash dividends to owners. (e) Increases in net assets in a period from nonowner sources. (f)Items characterized by service potential or future economic benefit. (g) Equals increase in assets less liabilities during the year,after adding distributions to owners and subtracting investments by owners. (h) Arises from income statement activities that constitute the entity's ongoing major or central operations. () Residual interest in the assets of the enterprise after deducting its liabilities. Increases assets during a period through sale of product. (k) Decreases assets during the period by purchasing the company's own stock. S Includes all changes in equity during the period,except those resulting from investments by own- ers and distributions to owners. (L06, E2-4 (Assumptions,Principles,and Constraints) Presented below are the assumptions,principles,and 7,8) constraints used in this chapter. 1. Economic entity assumption 5.Historical cost principle 9.Materiality Going concern assumption 6 Matching principle 10.Industry practices 3. Monetary unit assumption 7.Full disclosure principle 11.Conservatism 4.Periodicity assumption 8.Cost-benefit relationship Instructions Identify by number the accounting assumption,principle,or constraint that describes each situation be- low.Do not use a letter more than once. (a)Allocates expenses to revenues in the proper period. (b)Indicates that market value changes subsequent to purchase are not recorded in the accounts.(Do ⊕ not use revenue recognition principle.) (c) Ensures that all relevant financial information is reported (d)Rationale why plant assets are not reported at liquidation value.(Do not use historical cost principle.) (e) Anticipates all losses,but reports no gains. (f) Indicates that personal and business record keeping should be separately maintained (g) Separates financial information into time periods for reporting purposes. (h)Permits the use of market value valuation in certain specific situations. (1 Requires that information significant enough to affect the decision of reasonably informed users should be disclosed.(Do not use full disclosure principle.) ) Assumes that the dollar is the "measuring stick"used to report on financial performance. (L06, E2-5 (Assumptions,Principles,and Constraints)Presented below are a number of operational guide- 7,8) lines and practices that have developed over time. Instructions Select the assumption,principle,or constraint that most appropriately justifies these procedures and prac- tices.(Do not use qualitative characteristics.) (a)Market value changes are not recognized in the accounting records (b)Lower of cost or market is used to value inventories. (c)Financial information is presented so that investors will not be misled. (d)Intangible assets are capitalized and amortized over periods benefited. (e) Repair tools are expensed when purchased. (⑤ Agricultural companies use market value for purposes of valuing crops (g) Each enterprise is kept as a unit distinct from its owner or owners. (h) All significant postbalance sheet events are reported. ) Revenue is recorded at point of sale. (G) All important aspects of bond indentures are presented in financial statements. (k) Rationale for accrual accounting. ) The use of consolidated statements is justified. (m)Reporting must be done at defined time intervals (n)An allowance for doubtful accounts is established. (o)All payments out of petty cash are charged to Miscellaneous Expense.(Do not use conservatism.)
Instructions Identify the element or elements from page 51 associated with the 12 items below. (a) Arises from peripheral or incidental transactions. (b) Obligation to transfer resources arising from a past transaction. (c) Increases ownership interest. (d) Declares and pays cash dividends to owners. (e) Increases in net assets in a period from nonowner sources. (f) Items characterized by service potential or future economic benefit. (g) Equals increase in assets less liabilities during the year, after adding distributions to owners and subtracting investments by owners. (h) Arises from income statement activities that constitute the entity’s ongoing major or central operations. (i) Residual interest in the assets of the enterprise after deducting its liabilities. (j) Increases assets during a period through sale of product. (k) Decreases assets during the period by purchasing the company’s own stock. (l) Includes all changes in equity during the period, except those resulting from investments by owners and distributions to owners. E2-4 (Assumptions, Principles, and Constraints) Presented below are the assumptions, principles, and constraints used in this chapter. 1. Economic entity assumption 5. Historical cost principle 9. Materiality 2. Going concern assumption 6. Matching principle 10. Industry practices 3. Monetary unit assumption 7. Full disclosure principle 11. Conservatism 4. Periodicity assumption 8. Cost-benefit relationship Instructions Identify by number the accounting assumption, principle, or constraint that describes each situation below. Do not use a letter more than once. (a) Allocates expenses to revenues in the proper period. (b) Indicates that market value changes subsequent to purchase are not recorded in the accounts. (Do not use revenue recognition principle.) (c) Ensures that all relevant financial information is reported. (d) Rationale why plant assets are not reported at liquidation value. (Do not use historical cost principle.) (e) Anticipates all losses, but reports no gains. (f) Indicates that personal and business record keeping should be separately maintained. (g) Separates financial information into time periods for reporting purposes. (h) Permits the use of market value valuation in certain specific situations. (i) Requires that information significant enough to affect the decision of reasonably informed users should be disclosed. (Do not use full disclosure principle.) (j) Assumes that the dollar is the “measuring stick” used to report on financial performance. E2-5 (Assumptions, Principles, and Constraints) Presented below are a number of operational guidelines and practices that have developed over time. Instructions Select the assumption, principle, or constraint that most appropriately justifies these procedures and practices. (Do not use qualitative characteristics.) (a) Market value changes are not recognized in the accounting records. (b) Lower of cost or market is used to value inventories. (c) Financial information is presented so that investors will not be misled. (d) Intangible assets are capitalized and amortized over periods benefited. (e) Repair tools are expensed when purchased. (f) Agricultural companies use market value for purposes of valuing crops. (g) Each enterprise is kept as a unit distinct from its owner or owners. (h) All significant postbalance sheet events are reported. (i) Revenue is recorded at point of sale. (j) All important aspects of bond indentures are presented in financial statements. (k) Rationale for accrual accounting. (l) The use of consolidated statements is justified. (m) Reporting must be done at defined time intervals. (n) An allowance for doubtful accounts is established. (o) All payments out of petty cash are charged to Miscellaneous Expense. (Do not use conservatism.) 52 • Chapter 2 Conceptual Framework Underlying Financial Accounting (L0 6, 7, 8) (L0 6, 7, 8) 1460T_c02.qxd 12/31/05 09:10 am Page 52