Chapter 2

Information that is capable of making a difference in the decisions of users in their capacity as capital providers.

Relevance

Which of the following is NOT a benefit associated with the FASB Conceptual Framework Project? (A)A conceptual framework should increase financial statement users' understanding of and confidence in financial reporting. (B)A coherent set of accounting standards and rules should result. (C)Business entities will need far less assistance from accountants because the financial reporting process will be quite easy to apply. (D)Practical problems should be more quickly solvable by reference to an existing conceptual framework.

(C)Business entities will need far less assistance from accountants because the financial reporting process will be quite easy to apply.

SFAC No. 8 identifies the qualitative characteristics that make accounting information useful. Presented below are a number of questions related to these qualitative characteristics and underlying constraint. Timeliness Verifiability Relevance and Faithful Representation Comparability (Consistency) Comparability Confirmatory Value Cost Neutrality (a)What is the quality of information that enables users to confirm or correct prior expectations? (b)Identify the pervasive constraint developed in the conceptual framework. (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 faithful representation.) (d)Muruyama 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 faithful representation.) (f)What are the two fundamental qualities that make accounting information useful for decision-making? g)Watteau 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 fundamental qualities that make accounting information useful for decision-making purposes? (i)Duggan, 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? (j)Roddick 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 relevance or faithful representation.)

A. Confirmatory Value B. Cost C. Neutrality D. Comparability (Consistency) E. Neutrality F. Relevance and Faithful Representation G. Timeliness H. Relevance I. Comparability J. Verifiability

Information about an economic phenomenon that has value as an input to the processes used by capital providers to form their own expectations about the future.

Predictive

Quality of information that permits users to identify similarities in and differences between two sets of economic phenomena.

Comparability

Both GAAP and IFRS are increasing the use of fair value to report assets, but at this point GAAP has adopted it more broadly. True False

False

The difficulty in cost-benefit analysis is that the benefits are usually evident and easily measurable, while the costs are not always evident or measurable. True False

False

Information that has been measured and reported in a similar manner for different enterprises is considered consistent. True False

False Incorrect. Information that is measured and reported in a similar manner for different companies is considered comparable. Consistency is present when a company applies the same accounting treatment to similar events, from period to period.

Absence of bias intended to attain a predetermined result or to induce a particular behavior.

Neutrality

Having information available to users before it loses its capacity to influence decisions.

Timeliness

The conceptual framework contains how many Statements of Financial Accounting Concepts that relate to financial reporting for business enterprises? a. 7 b. 5 c. 4 d. 6

a. 7

What accounting assumption, principle, or constraint would Target Corporation use in each of the situations below? Revenue Recognition Cost Constraint Economic Entity Historical Cost Industry Practices Full Disclosure Expense Recognition Going Concern Monetary UnitPeriodicity (a)Target was involved in litigation over the last year. This litigation is disclosed in the financial statements. (b)Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets. (c)Target records the purchase of a new Dell PC at its cash equivalent price.

a. Full Disclosure; b. Expense Recognition; c. Historical Cost

Vande Velde Company made three investments during 2017. Where will Vande Velde report these investments in the fair value hierarchy? Level 1 Level 2 Level 3 a. It purchased 1,000 shares of Sastre Company, a start-up company. Vande Velde made the investment based on valuation estimates from an internally developed model. b. It purchased 2,000 shares of GE stock, which trades on the NYSE. c. It invested $10,000 in local development authority bonds. Although these bonds do not trade on an active market, their value closely tracks movements in U.S. Treasury bonds.

a. Level 3; b. Level 1; c. Level 2

Presented below are a number of operational guidelines and practices that have developed over time.Select the assumption, principle, or constraint that most appropriately justifies these procedures and practices. (Do not use qualitative characteristics.) Revenue Recognition Principle Expense Recognition and Revenue Recognition Principles Full Disclosure Principle Expense Recognition Principle Materiality Measurement Principle (fair value) Measurement Principle and Expense Recognition Principle Economic Entity Assumption Periodicity Assumption Measurement Principle (historical cost) (a)Fair value changes are not recognized in the accounting records. (b)Financial information is presented so that investors will not be misled. (c)Intangible assets are amortized over periods benefited. (d)Agricultural companies use fair value for purposes of valuing crops. (e)Each enterprise is kept as a unit distinct from its owner or owners. (f)All significant post-balance-sheet events are disclosed. (g)Revenue is recorded when the product is delivered. (h)All important aspects of bond indentures are presented in financial statements. (i)Rationale for accrual accounting. (j)The use of consolidated statements is justified. (k)Reporting must be done at defined time intervals. (l)An allowance for doubtful accounts is established. (m)Goodwill is recorded only at time of purchase. Economic (n)A company charges its sales commission costs to expense.

a. Measurement Principle (historical cost) b. Full Disclosure Principle c. Expense Recognition Principle d. Measurement Principle (fair value) e. Economic Entity Assumption f. Full Disclosure Principle g. Revenue Recognition Principle h. Full Disclosure Principle i. Expense Recognition and Revenue Recognition Principles j. Economic Entity Assumption k. Periodicity Assumption l. Measurement Principle and Expense Recognition Principle m. Measurement Principle (historical cost) n. Expense Recognition Principle

In the United States, inflation/deflation is ignored in accounting under which of the following assumptions? a. Monetary unit assumption. b. Periodicity assumption. c. Going concern assumption. d. Time period assumption.

a. Monetary unit assumption.

Identify which basic assumption of accounting is best described in each item below. Periodicity Monetary Unit Economic Entity Going Concern (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.

a. Periodicity; b. Monetary Unit; c. Going Concern; d . Economic Entity

Identify which basic principle of accounting is best described in each item below. Measurement (fair value) Measurement (historical cost) Full Disclosure Revenue Recognition Expense Recognition (a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected. (b) Yahoo! 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) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.

a. Revenue Recognition; b. Expense Recognition; c. Full Disclosure; d. Measurement (historical cost)

If the going concern assumption is not made in accounting, what value would be disclosed in the financial statements for the following items. Would not be Disclosed Would be disclosed at Net Realizable Value (a)Land (b)Unamortized bond premium (c)Depreciation expense on equipment (d)Inventory (e)Prepaid insurance

a. Would be disclosed at Net Realizable Value; b. Would not be Disclosed; c. Would not be Disclosed; d. Would be disclosed at Net Realizable Value; e. Would be disclosed at Net Realizable Value

Identify 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.

a. Yes; b. No; c. No

Presented below are three different transactions related to materiality. Do you classify these transactions as material? (a)Blair 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. YesNo (b)Hindi Co. has an unusual 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. Hindi Co.'s income for the current year was $10 million. YesNo (c)Damon 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.

a. Yes; b. Yes; c. No

The change in equity (net assets) of an entity during a period from transactions and other events and circumstances from non-owner sources is called a. comprehensive income. b. net income. c. gains. d. revenues.

a. comprehensive income.

he objective of general-purpose financial reporting is? a. to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers b. to provide users with financial information that implies total freedom from error c. to provide a metric for financial information used to determine when the boundary between two or more entities should be disregarded and the entities considered to be a licensing arrangement d. to provide companies with the option to select information that favors one set of interested parties over another

a. to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers

Companies and their auditors generally have adopted a rule of thumb that anything under _____ of net income is considered not material. a. 10% b. 5% c. 15% d. 2%

b. 5%

Which of the following is an argument against using historical cost in accounting? a. Historical costs are based on an exchange transaction. b. Fair values are more relevant. c. Historical costs are reliable. d. Fair values are subjective.

b. Fair values are more relevant.

Which accounting assumption or principle is being violated if a company is a party to major litigation that it may lose and decides not to include the information in the financial statements because it may have a negative impact on the company's stock price? a. Historical cost. b. Full disclosure. c. Expense recognition. d. Going concern.

b. Full disclosure.

Which of the following is a component of the revenue recognition principle? a. Cash is realized or realizable and production is complete. b. Recognition occurs when the performance obligation is satisfied. c. Production is complete and there is an active market for the product. d. Cash is received and the amount is material

b. Recognition occurs when the performance obligation is satisfied.

Which of the following serves as the justification for the periodic recording of depreciation expense? a. Immediate recognition of an expense. b. Systematic and rational allocation of cost over the periods benefited. c. Association of efforts (expense) with accomplishments (revenue). d. Minimization of income tax liability.

b. Systematic and rational allocation of cost over the periods benefited.

Financial information exhibits the characteristic of consistency when a. expenses are reported as charges against revenue in the period in which they are paid. b. a company applies the same accounting treatment to similar events, from period to period. c. extraordinary gains and losses are not included on the income statement. d. accounting procedures are adopted which give a consistent rate of net income.

b. a company applies the same accounting treatment to similar events, from period to period.

Application of the full disclosure principle a. requires that the financial statements be consistent and comparable. b. is demonstrated by the use of supplementary information explaining the effects of financing arrangements. c. is theoretically desirable but not practical because the costs of complete disclosure exceed the benefits. d. is violated when important financial information is buried in the notes to the financial statements.

b. is demonstrated by the use of supplementary information explaining the effects of financing arrangements.

Which of the following is not among the ingredients of the fundamental quality of faithful representation? a. neutrality. b. materiality. c. completeness. d. free from error.

b. materiality.

Enhancing qualities of accounting information include all of the following except: a. understandability. b. neutrality. c. timeliness. d. comparability.

b. neutrality.

Proponents of historical cost ordinarily maintain that in comparison with all other valuation alternatives for general purpose financial reporting, statements prepared using historical costs are more a. indicative of the entity's purchasing power. b. verifiable. c. relevant. d. conservative.

b. verifiable.

Revenue generally should be recognized a. at the end of production. b. when the performance obligation is satisfied. c. at the time of cash collection. d. when realized.

b. when the performance obligation is satisfied.

Which of the following statements is true regarding the conceptual frameworks developed by FASB and IASB? a. The economic entity assumption is not part of the framework due to cultural differences. b. The monetary unit assumption is part of each framework and the U.S. dollar will be the established as the common unit of currency. c. Both have similar measurement principles based on historical cost and fair value. d. The existing conceptual frameworks underlying U.S. GAAP and IFRS are quite dissimilar.

c. Both have similar measurement principles based on historical cost and fair value.

When a company changes accounting principles, it financial statements lack ______________. a. predictive value b. faithful representation c. consistency d. confirmatory value

c. consistency

Preparation of merged financial statements when a parent-subsidiary relationship exists does not violate the a. comparability characteristic. b. neutrality characteristic. c. economic entity assumption. d. relevance characteristic.

c. economic entity assumption.

Depreciation and amortization policies are justifiable and appropriate only if we assume some permanence to the company because of the: a. periodicity assumption. b. economic entity assumption. c. going concern assumption. d. monetary unit assumption.

c. going concern assumption.

The accounting principle of expense recognition is best demonstrated by a. not recognizing any expense unless some revenue is realized. b. recognizing prepaid rent received as revenue. c. matching effort (expense) with accomplishment (revenue). d. establishing an Appropriation for Contingencies account.

c. matching effort (expense) with accomplishment (revenue).

Allowing firms to estimate rather than physically count inventory at interim (quarterly) periods is an example of a trade-off between a. verifiability and faithful representation. b. faithful representation and comparability. c. timeliness and verifiability. d. neutrality and consistency.

c. timeliness and verifiability.

Which level of the conceptual framework is devoted to elements of financial statements and the qualitative characteristics? a. 1st b. 4th c. 3rd d. 2nd

d. 2nd

A company has a factory building that originally cost the company $250,000. The current fair value of the factory building is $3 million. The president would like to report the difference as a gain. The write-up would represent a violation of which accounting assumption or principle? a. Going concern b. Monetary unit c. Revenue recognition d. Historical cost

d. Historical cost

With regard to fair value, which of the following measurements is considered the least subjective? a. For purposes of fair value, all of the measures are considered equally subjective. b. Unobservable inputs. c. Inputs that are observable either directly or through corroboration with observable data. d. Observable inputs that reflect quoted prices for identical assets or liabilities.

d. Observable inputs that reflect quoted prices for identical assets or liabilities.

A conceptual framework establishes the concepts that provide guidance on a selecting the transactions, other events, and circumstances to be represented, b. how transactions, events and circumstances should be recognized and measured. c. identifying the boundaries of financial reporting. d. all of these answer choices are correct.

d. all of these answer choices are correct.

To be recognized in the main body of financial statements, an item should a. meet the definition of a basic element. b. be relevant and reliable. c. be measurable with sufficient certainty. d. all of these answer choices are correct.

d. all of these answer choices are correct.

The objective of general-purpose financial reporting in the conceptual framework is a. understandability. b. reliability. c. comparability. d. decision usefulness.

d. decision usefulness.

Generally, revenues are recognized when the: a. All of these answer choices are correct. b. cash is received. c. product is produced. d. performance obligation is satisfied.

d. performance obligation is satisfied.

In 2010, the FASB and IASB agreed on a. the constraints of financial reporting. b. all of these answer choices are correct. c. a common set of elements for financial statements. d. the objective of financial reporting and a common set of desired qualitative characteristics.

d. the objective of financial reporting and a common set of desired qualitative characteristics.

Materiality is used in all of the following situations of providing financial information, except a. where omission of the information would result in bias. b. where it would impact the judgment of a reasonable person. c. where an amount is of relative large size and importance. d. where it would not make a difference in the actions of a decision maker.

d. where it would not make a difference in the actions of a decision maker.