Accounting Intermediate Krylova Ch2

Materiality and relevance are both defined by A. What influences or makes a difference to a decision maker. B. Quantitative criteria set by the Financial Accounting Standards Board. C. The consistency in the application of methods over time. D. The perceived benefits to be denied that exceed the perceived costs associated with it

A. *Correct Answer* Both materiality and relevance are characteristics defined by their ability to influence or make a difference to a decision maker. Materiality is an entityspecific aspect of relevance based on the nature, magnitude, or both of the items to which the information relates in the context of an individual entity's financial report. B. Materiality is an entityspecific aspect of relevance based on the nature, magnitude, or both of the items to which the information relates in the context of an individual entity's financial report. Consequently, a uniform quantitative threshold cannot be set. C. The enhancing qualitative characteristic of comparability relates to consistency in the application of methods over time. D. The costbenefit constraint on useful financial reporting compares the perceived benefits and costs associated with financial information.

A department store ordinarily recognizes revenue when A. Merchandise to be held for resale is received from suppliers. B. Payment is received from customers. C. Customers receive merchandise. D. Preparation of merchandise for resale has been completed.

A. Revenues should be recognized when they are realized or realizable and earned. Revenues are realized when products, merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues, such as receipt of merchandise by the customers. B. Revenues should be recognized when they are realized or realizable and earned. Revenues are realized when products, merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues, such as receipt of merchandise by the customers. C. *Correct Answer* Revenues should be recognized when they are realized or realizable and earned. Revenues are realized when products, merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues, such as receipt of merchandise by the customers. D. Revenues should be recognized when they are realized or realizable and earned. Revenues are realized when products, merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues, such as receipt of merchandise by the customers.

According to the FASB's conceptual framework, which of the following enhances information that is relevant and faithfully represented? A. Comparability. B. Confirmatory value. C. Neutrality. D. Materiality.

A. *Correct Answer* Comparability is a qualitative characteristic that enhances the usefulness of relevant and faithfully represented information. It enables users to identify similarities in and differences among items. B. Relevance is a fundamental qualitative characteristic. Relevant information is able to make a difference in user decisions. To do so, it must have predictive value, confirmatory value, or both. Something has confirmatory value with respect to prior evaluations if it provides feedback that confirms or changes (corrects) them. C. Faithful representation is a fundamental qualitative characteristic. A perfectly faithful representation is complete, neutral, and free from error. Faithfully represented information is neutral if it is unbiased in its selection or presentation of information. D. Information is material if its omission or misstatement can influence user decisions based on a specific entity's financial information. Thus, it is an entityspecific aspect of relevance.

Which of the following is considered a pervasive constraint by the FASB's conceptual framework? A. Cost. B. Conservatism. C. Timeliness. D. Verifiability

A. *Correct Answer* Cost is a pervasive constraint on the information provided by financial reporting. The benefits of financial information should exceed the costs of reporting. B. Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. However, conservatism does not permit a deliberate understatement of total assets and net income. Furthermore, SFAC 5 describes "a general tendency to emphasize purchase and sale transactions and to apply conservative procedures in accounting recognition." This tendency is a response to uncertainty. C. Timeliness is an enhancing qualitative characteristic. D. Verifiability is an enhancing qualitative characteristic.

Some costs cannot be directly related to particular revenues but are incurred to obtain benefits that are exhausted in the period in which the costs are incurred. An example of such a cost is A. Salespersons' monthly salaries. B. Salespersons' commissions. C. Transportation to customers' places of business. D. Prepaid insurance

A. *Correct Answer* Expenses should be recognized when a benefit has been consumed. The consumption of benefit may occur when (1) the expenses are matched with the revenues, (2) they are allocated on a systematic and rational basis to the periods in which the related assets are expected to provide benefits, or (3) the cash is spent or liabilities are incurred for goods and services that are used up either simultaneously with the acquisition or soon after. An example of a cost that (1) cannot be directly related to particular revenues but (2) is incurred to obtain benefits that are exhausted in the same period in which the cost is incurred is salespersons' monthly salaries. B. Salespersons' commissions (not salaries) are recognized upon recognition of revenues that result directly and jointly from the same transactions or other events as the cost. C. Transportation to customers' places of business is recognized upon recognition of revenues that result directly and jointly from the same transactions or other events as the cost. D. Prepaid insurance benefits more than one accounting period. Its cost should be allocated on a systematic and rational basis to the accounting periods benefited.

What is the purpose of information presented in notes to the financial statements? A. To provide disclosures required by generally accepted accounting principles. B. To correct improper presentation in the financial statements. C. To provide recognition of amounts not included in the totals of the financial statements. D. To present management's responses to auditor comments

A. *Correct Answer* Notes are an integral part of the basic financial statements. Notes provide information essential to understanding the financial statements, including disclosures required by GAAP. B. Notes may not be used to rectify an improper presentation. C. Disclosure in notes is not a substitute for recognition in financial statements for items that meet recognition criteria. D. Management's responses to auditor comments are not an appropriate subject of financial reporting.

The appropriate attribute for measuring plant assets is A. Historical cost. B. Current cost. C. Net realizable value. D. Present value of future cash flows.

A. *Correct Answer* Plant assets should be measured at historical cost. Property, plant, and equipment and most inventories are reported at historical cost. B. Current cost is used to measure certain inventories. C. Net realizable value most often is used to measure shortterm receivables and some inventories. D. Present value most often is used for longterm receivables and payables

According to the FASB conceptual framework, which of the following correctly pairs a fundamental qualitative characteristic of useful financial information with one of its aspects? A. Relevance and materiality. B. Relevance and neutrality. C. Faithful representation and predictive value. D. Faithful representation and confirmatory value

A. *Correct Answer* Relevance is a fundamental qualitative characteristic, and materiality is an entityspecific aspect of relevance. Relevant information is able to make a difference in user decisions. To do so, it must have predictive value, confirmatory value, or both. Information is material if its omission or misstatement can influence user decisions based on a specific entity's financial information. B. Relevance and faithful representation are the fundamental qualitative characteristics. A representation is perfectly faithful if it is complete, neutral, and free from error. C. Relevant information has predictive value, confirmatory value, or both. D. Relevant information has predictive value, confirmatory value, or both.

Robin Gavaskar, who recently founded a company that produces baseball bats and balls, wants to determine her company's policy for revenue recognition. According to the revenue recognition principle, the most appropriate time to recognize revenue would be when A. The sale occurs. B. Cash is received. C. Production is completed. D. Quarterly financial statements are prepared.

A. *Correct Answer* Revenues are normally recognized when they are realized or realizable and earned. Revenues are realized (or realizable) when goods or services have been exchanged for cash or claims to cash (assets readily convertible to cash). Revenues are earned when the earning process is substantially complete, and the entity is entitled to the resulting benefits or revenues. The revenue recognition criteria are ordinarily met at the point of sale (time of delivery of goods or services). B. Under the accrual basis of accounting, revenue is not necessarily recognized when cash is received. C. The criteria for revenue recognition ordinarily have not been met until the product is sold. D. Under the accrual basis of accounting, revenues normally are recognized when they are realized or realizable and earned, regardless of when the financial statements are prepared.

What is the underlying concept governing the generally accepted accounting principles pertaining to recording gain contingencies? A. Conservatism. B. Relevance. C. Consistency. D. Faithful representation.

A. *Correct Answer* Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. However, conservatism does not permit a deliberate understatement of total assets and net income. Furthermore, the response to uncertainty reflects "a general tendency to emphasize purchase and sale transactions and to apply conservative procedures in accounting recognition" (SFAC 5). Thus, a loss, not a gain, contingency is recorded in the financial statements. If the probability of realization of a gain is high, the contingency is disclosed in the notes. B. Relevance relates to the capacity of information to affect a decision. C. Consistency requires the application of the same accounting principles to the same items. D. Faithful representation is a fundamental qualitative characteristic. Useful information faithfully represents the economic events that it purports to represent.

According to the FASB's conceptual framework, an entity's revenue may result from a(n) A. Decrease in an asset from primary operations. B. Increase in an asset from incidental transactions. C. Increase in a liability from incidental transactions. D. Decrease in a liability from primary operations.

A. A decrease in an asset from primary operations results in an expense. B. An increase in an asset from incidental transactions results in a gain. C. An increase in a liability from incidental transactions results in a loss. D. *Correct Answer* Revenues are inflows or other enhancements of assets or settlements of liabilities from activities that constitute the entity's ongoing major or central operations. Thus, a revenue may result from a decrease in a liability from primary operations, for example, by delivering goods that were paid for in advance.

One of the elements of financial statements is comprehensive income. Comprehensive income for a period excludes changes in equity resulting from which of the following? A. Loss from discontinued operations. B. Priorperiod error correction. C. Dividends paid to shareholders. D. Unrealized loss on availableforsale securities.

A. A loss from discontinued operations is a change in equity from nonowner sources. B. A priorperiod error correction is not a change in equity during the current period. Comprehensive income for a period equals net income for that period adjusted for certain other nonowner changes in equity, such as holding gains and losses on availableforsale securities and foreign currency translation adjustments. A priorperiod error correction is recognized neither in current net income nor as a nonowner change in equity. C. *Correct Answer* According to the FASB's conceptual framework, comprehensive income of a business entity is the periodic change in equity of a business from nonowner sources. Thus, dividends paid (distributions to owners) are excluded from comprehensive income. D. An unrealized loss on availableforsale securities is included in comprehensive income but not earnings.

An accrued expense can best be described as an amount A. Paid and currently matched with earnings. B. Paid and not currently matched with earnings. C. Not paid and not currently matched with earnings. D. Not paid and currently matched with earnings

A. An expense paid in the same period in which it is incurred is not accrued and does not require an adjusting entry. B. An amount paid and not currently matched with earnings is a deferral of expense. C. An expense neither paid nor incurred requires no original entry and no adjusting entry. D. *Correct Answer* An accrued expense is one that has been incurred but not paid. Thus, it should be charged (matched) against revenue in the current period and recorded as a liability

Under a royalty agreement with another entity, a company will receive royalties from the assignment of a patent for 3 years. The royalties received should be reported as revenue A. At the date of the royalty agreement. B. In the period earned. C. In the period received. D. Evenly over the life of the royalty agreement

A. At the date of the royalty agreement, the contract is wholly executory. The recognition criteria have not been met, and no asset, revenue, or liability is recognized. B. *Correct Answer* Revenues should be recognized when they are realized or realizable and earned. Revenues are realized when products, merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. The earning process includes the activities that produce revenue, for example, (1) allowing other entities to use entity assets (such as patents) or (2) the occurrence of an event specified in a contract (such as production using the patented technology). C. Royalties received before they are earned are credited to a liability. D. Revenue is recognized evenly over the life of the royalty agreement only if earned evenly over that period.

Why are certain costs of doing business capitalized when incurred and then depreciated or amortized over subsequent accounting cycles? A. To reduce the federal income tax liability. B. To aid management in the decisionmaking process. C. To match the costs of production with revenues as earned. D. To adhere to the accounting concept of conservatism

A. Capitalization and depreciation of costs on the financial statements have no effect on federal income tax liability. B. Expense recognition principles are applied to benefit all users of financial statements, not merely management. C. *Correct Answer* If costs benefit more than one accounting period, they should be systematically and rationally allocated to all periods benefited. This is done by capitalizing the costs and depreciating or amortizing them over the periods in which the asset helps generate revenue. The term "matching" is most narrowly defined as the expense recognition principle of associating cause and effect, but it is sometimes used more broadly (as here) to apply to the entire process of expense recognition or even of income determination. D. The accounting concept of conservatism requires a prudent approach to uncertainty but without the introduction of bias into financial reporting. Thus, the more conservative approach might be to recognize all costs immediately.

According to the FASB's conceptual framework, which of the following is an essential characteristic of an asset? A. The claims to an asset's benefits are legally enforceable. B. An asset is tangible. C. An asset is obtained at a cost. D. An asset provides future benefits.

A. Claims to an asset's benefits may not be legally enforceable. Goodwill is an example. B. Some assets are intangible. C. Assets may be obtained through donations or investments by owners. D. *Correct Answer* One of the three essential characteristics of an asset is that the transaction or event giving rise to the entity's right to or control of its assets has already occurred. It is not expected to occur in the future. A second essential characteristic of an asset is that an entity can obtain the benefits of and control others' access to the asset. The third essential characteristic is that an asset must embody a probable future benefit that involves a capacity to contribute to future net cash inflows.

According to the FASB's conceptual framework, the usefulness of providing information in financial statements is subject to the constraint of A. Consistency. B. Cost. C. Relevance. D. Representational faithfulness

A. Consistency is a means of achieving comparability, an enhancing qualitative characteristic. It is the use of the same methods, for example, accounting principles, for the same items. B. *Correct Answer* Cost is a pervasive constraint on the information provided by financial reporting. The benefits of financial information should exceed the costs of reporting. C. Relevance is a fundamental qualitative characteristic of useful information, not a constraint. D. Faithful representation is a fundamental qualitative characteristic of useful information, not a constraint.

According to the FASB's conceptual framework, which of the following is not an element describing transactions, events, and circumstances during intervals of time? A. Distributions to owners. B. Rational allocation procedures. C. Investments by owners. D. Comprehensive income

A. Distributions to owners are such an element. B. *Correct Answer* Several elements describe transactions, events, and circumstances during intervals of time, including investments by owners, distributions to owners, comprehensive income, revenues, expenses, gains, and losses. Rational allocation procedures are used in accrual accounting. C. Investments by owners are such an element. D. Comprehensive income is such an element.

All of the following are defined as elements of an income statement except A. Expenses. B. Shareholders' equity. C. Gains and losses. D. Revenues.

A. Expenses are an element of an income statement. B. *Correct Answer* Equity of a business entity (or the net assets of a nonbusiness organization) is a residual amount that reflects the basic accounting equation: assets minus liabilities equals equity (or net assets). It is reported on the statement of financial position. C. Gains and losses are elements of an income statement. D. Revenues are an element of an income statement.

According to the FASB's conceptual framework, which of the following best describes the distinction between expenses and losses? A. Losses are reported net of related tax effect, and expenses are not B. Losses are decreases in net assets, and expenses are not. C. Losses are material, and expenses are immaterial. D. Losses result from peripheral or incidental transactions, and expenses result from ongoing major or central operations of the entity.

A. Expenses result from ongoing operations, and losses result from peripheral transactions. B. Expenses result from ongoing operations, and losses result from peripheral transactions. Both losses and expenses decrease equity (net assets). C. Expenses result from ongoing operations, and losses result from peripheral transactions. D. *Correct Answer* According to the FASB's conceptual framework, expenses are outflows or other uses of assets or incurrences of liabilities (or both) from (1) delivering or producing goods, (2) providing services, or (3) other activities that qualify as ongoing major or central operations. Losses are decreases in equity (net assets) other than expenses or distributions to owners.

During the lifetime of an entity, accountants produce financial statements at arbitrary moments in time in accordance with which basic accounting concept? A. Verifiability. B. Periodicity. C. Conservatism. D. Matching

A. Information is verifiable if knowledgeable and independent observers can reach a consensus that it is faithfully represented. B. *Correct Answer* A basic feature of the financial accounting process is that information about the economic activities of the business should be issued at regular intervals. These time periods should be of equal length to facilitate comparability. They also should be of relatively short duration, e.g., 1 year, to provide business information useful for decision making. C. Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. However, conservatism does not permit a deliberate understatement of total assets and net income. Furthermore, SFAC 5 describes "a general tendency to emphasize purchase and sale transactions and to apply conservative procedures in accounting recognition." This tendency is a response to uncertainty. D. Matching (another term for associating cause and effect) requires costs to be recognized as expenses on the basis of their direct association with specific revenues to the extent possible.

According to the FASB's conceptual framework, which of the following decreases shareholder equity? A. Investments by owners. B. Distributions to owners. C. Issuance of stock. D. Acquisition of assets in a cash transaction

A. Investments by owners increase assets and equity. B. *Correct Answer* Equity equals assets minus liabilities. Accordingly, transactions that decrease assets without affecting liabilities also decrease equity. Distributions to owners, such as payments of dividends (debit retained earnings and credit dividends payable, then debit dividends payable and credit cash), are such transactions. C. An issuance of stock results either in no change in equity (e.g., a stock split or stock dividend) or an increase. D. Acquisition of assets in a cash transaction has no effect on equity

Continuation of an accounting entity in the absence of evidence to the contrary is an example of the basic concept of A. Accounting entity. B. Consistency. C. Going concern. D. Substance over form.

A. The accounting entity concept refers to the business entity, which may or may not be synonymous with the legal entity. The emphasis also is on the separation of the entity from its ownership. B. Consistency is the use of the same methods for the same items either (1) from one period to the next within a reporting entity or (2) in one period across entities. C. *Correct Answer* A basic feature of financial accounting is that a business is assumed to be a going concern in the absence of evidence to the contrary. The goingconcern concept is based on the empirical observation that many entities have an indefinite life. D. The concept of substance over form requires accounting to be based upon the economic substance of events rather than upon the legal form.

According to the FASB's conceptual framework, which of the following most likely does not violate the concept of faithful representation? A. Financial statements were issued 9 months late. B. Report data on segments having the same expected risks and growth rates to analysts estimating future profits. C. Financial statements included property with a carrying amount increased to management's estimate of market value. D. Management reports to shareholders regularly refer to new projects undertaken, but the financial statements never report project results.

A. Late issuance is a matter of timeliness. Timeliness is a qualitative characteristic that enhances relevance and faithful representation. Information is timely when it is available in time to influence decisions. B. *Correct Answer* A representation is perfectly faithful if it is (1) complete (containing what is needed for user understanding), (2) neutral (unbiased in its selection or presentation), and (3) free from error. The faithful representation of any given information is logically unrelated to whether the segments have the same expected risks and growth rates (assuming freedom from error) or the identity of the users. C. Management's estimate of market value may not be verifiable. Verifiability is a qualitative characteristic that enhances relevance and faithful representation. Information is verifiable (directly or indirectly) if knowledgeable and independent observers can reach a consensus (not necessarily unanimity) that it is faithfully represented. D. Failure to report results is a matter of timeliness. Timeliness is a qualitative characteristic that enhances relevance and faithful representation. Information is timely when it is available in time to influence decisions.

Which of the following accounting concepts states that an accounting transaction should be supported by sufficient evidence to allow two or more qualified individuals to arrive at essentially similar measures and conclusions? A. Matching. B. Verifiability. C. Periodicity. D. Stable monetary unit

A. Matching associates cause and effect, for example, recognition in the same period of revenues and the expenses incurred to produce them. B. *Correct Answer* Verifiability is a qualitative characteristic that enhances relevance and faithful representation. Information is verifiable (directly or indirectly) if knowledgeable and independent observers can reach a consensus (but not necessarily unanimity) that it is faithfully represented. C. Periodicity is the assumption that accounting information is reported at regular intervals to provide comparability and at relatively short intervals to provide useful information. D. The stable monetary unit assumption is that the purchasing power of the unit of measure (e.g., the U.S. dollar) does not fluctuate

According to the FASB's conceptual framework, recognition is the process of formally incorporating an element into the financial statements of an entity. Recognition criteria include all of the following except A. Measurability with sufficient reliability. B. Definitions of elements of financial statements. C. Decision usefulness. D. Relevance.

A. Measurability with sufficient reliability is included in the recognition criteria. B. Definitions of elements of financial statements are included in the recognition criteria. C. *Correct Answer* An item and information about the item should be recognized when the following four fundamental recognition criteria are met: (1) The item meets the definition of an element of financial statements; (2) it has a relevant attribute measurable with sufficient reliability; (3) the information about the item is capable of making a difference in user decisions; and (4) the information is representationally faithful, verifiable, and neutral. Decision usefulness is a userspecific quality of accounting information. D. Relevance is included in the recognition criteria

According to the FASB's conceptual framework, the two fundamental qualitative characteristics that make accounting information useful for decision making are A. Neutrality and completeness. B. Fairness and precision. C. Relevance and faithful representation. D. Consistency and comparability.

A. Neutrality and completeness are aspects of faithful representation. B. Accounting information should be fairly presented, but precision (perfect accuracy) is not always possible when estimates are necessary. C. *Correct Answer* Relevance and faithful representation are the fundamental qualities that make accounting information useful for decision making. Relevance is the capacity of information to make a difference in the user's decision. A representation is perfectly faithful if it is complete, neutral, and free from error. D. Comparability is a qualitative characteristic that enhances the usefulness of relevant and faithfully represented information. Consistency helps achieve comparability.

According to the FASB's conceptual framework, neutrality relates to Faithful Representation Relevance A. Yes Yes B. Yes No C. No Yes D. No No

A. Neutrality relates to faithful representation, not relevance. B. *Correct Answer* A representation is perfectly faithful if it is (1) complete (containing what is needed for user understanding), (2) neutral (unbiased in its selection or presentation), and (3) free from error (but not necessarily perfectly accurate). Relevant information is able to make a difference in user decisions. To do so, it must have predictive value, confirmatory value, or both. C. Neutrality relates to faithful representation, not relevance. D. Neutrality relates to faithful representation, not relevance.

According to Statements of Financial Accounting Concepts, predictive value relates to Faithful Relevance Representation A. No No B. Yes Yes C. No Yes D. Yes No

A. Predictive value relates to relevance. B. Predictive value relates to relevance, not faithful representation. C. Predictive value relates to relevance, not faithful representation. D. *Correct Answer* Relevance is a fundamental qualitative characteristic of useful financial information. It is the capacity of information to make a difference in a decision. It must have (1) predictive value, (2) confirmatory value, or both. Moreover, materiality is an entityspecific aspect of relevance. Something has predictive value if it can be used in a predictive process. Something has confirmatory value with respect to prior evaluations if it provides feedback that confirms or changes (corrects) them.

A company provides the following information: Cash Receipts from Customers: Year 1 Year 2 Year 3 From Year 1 sales $95,000 $120,000 From Year 2 sales 200,000 $ 75,000 From Year 3 sales 50,000 225,000 What is the accrualbased revenue for Year 2? A. $200,000 B. $275,000 C. $320,000 D. $370,000

A. The amount of $200,000 equals cash collected in Year 2 for sales from Year 2. B. *Correct Answer* Under the accrual method, revenues and gains are realized when goods or services have been exchanged for cash or claims to cash, not when that cash is collected. Consequently, given that total cash collected for Year 2 sales is $275,000 ($200,000 Year 2 + $75,000 Year 3), revenue for Year 2 is $275,000. C. The amount of $320,000 equals cash collected in Year 2 for sales from Year 1 and Year 2. D. The amount of $370,000 equals cash collected in Year 2

Which of the following is a generally accepted accounting principle that illustrates the practice of conservatism during a particular reporting period? A. Capitalization of research and development costs. B. Accrual of a contingency deemed to be reasonably possible. C. Reporting investments with appreciated market values at market value. D. Reporting inventory at the lower of cost or market value.

A. R&D costs normally are expensed as incurred. B. Most contingent losses are recognized only if probable and capable of being reasonably estimated. However, the fair value of a guarantee is accrued even if the payment is not probable. C. Recognizing unrealized holding gains on investments, e.g., trading securities, does not result in a conservative balance sheet or earnings amount. D. *Correct Answer* Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. An understatement of assets is to be avoided so that earnings are not overstated when the assets are realized. Accordingly, the market measurement under the LCM rule is subject to a ceiling of net realizable value and a floor of NRV minus a normal profit. Reporting inventory above NRV will result in a loss on sale. Reporting inventory below NRV minus a normal profit will result in an overstatement of profit. Thus, the LCM rule results in a conservative balance sheet without an unduly conservative measurement that will overstate earnings and retained earnings.

For $50 a month, Rawl Co. visits its customers' premises and performs insect control services. If customers experience problems between regularly scheduled visits, Rawl makes service calls at no additional charge. Instead of paying monthly, customers may pay an annual fee of $540 in advance. For a customer who pays the annual fee in advance, Rawl should recognize the related revenue A. When the cash is collected. B. At the end of the fiscal year. C. At the end of the contract year after all of the services have been performed. D. Evenly over the contract year as the services are performed.

A. Recognition when cash is collected is appropriate when the cash basis is used. B. The revenue should be recognized evenly over the contract year. C. The revenue should be recognized evenly over the contract year. D. *Correct Answer* Accrualbased revenue should be recognized when realized or realizable and earned. These conditions are usually met when services are rendered. Because these services require monthly visits for monthly fees, the annual payment should be recognized evenly over the period in which services are performed.

Under SFAC 8, the ability, through consensus among measurers, to ensure that information represents what it purports to represent is an example of the concept of A. Relevance. B. Verifiability. C. Comparability. D. Predictive value

A. Relevance (a fundamental qualitative characteristic) is the capacity of information to make a difference in a decision. B. *Correct Answer* Verifiability is a qualitative characteristic that enhances relevance and faithful representation. Information is verifiable (directly or indirectly) if knowledgeable and independent observers can reach a consensus (not necessarily unanimity) that it is faithfully represented. C. Comparability (an enhancing qualitative characteristic) is the quality of information that enables users to identify similarities and differences among items. D. Relevant information is able to make a difference in user decisions. To do so, it must have predictive value, confirmatory value, or both. Something has predictive value if it can be used as an input in a predictive process.

According to the FASB's conceptual framework, what does the concept of faithful representation in financial reporting include? A. Predictive value. B. Certainty. C. Perfect accuracy. D. Neutrality

A. Relevant information has predictive value, confirmatory value, or both. Faithfully represented information is not necessarily relevant. B. Certainty and perfect accuracy are not implied by faithful representation. The financial statements are a model of the reporting entity. This model may be representationally faithful for its intended purposes without corresponding precisely to the realworld original. Thus, immaterial uncertainty does not impair faithful representation. C. Faithful representation includes the concept of perfect faithfulness, not perfect accuracy. D. *Correct Answer* Faithful representation and relevance are the fundamental qualitative characteristics of accounting information. A perfectly faithful representation is complete, neutral, and free from error. Faithfully represented information is neutral if it is unbiased in its selection or presentation of information.

According to the FASB's conceptual framework, the quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called A. Confirmatory value. B. Predictive value. C. Representational faithfulness. D. Comparability.

A. Relevant information must have predictive value, confirmatory value, or both. Something has confirmatory value with respect to prior evaluations if it provides feedback that confirms or changes (corrects) them. B. *Correct Answer* Relevant information is able to make a difference in user decisions. To do so, it must have predictive value, confirmatory value, or both. Financial information has predictive value if it can be used as an input in a predictive process. C. Faithful representation is a fundamental qualitative characteristic. A perfectly faithful representation is complete, neutral, and free from error. D. Comparability is an enhancing qualitative characteristic. Information should be comparable with similar information for (1) other entities and (2) the same entity for another period or date. Thus, comparability allows users to understand similarities and differences.

Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization? A. Reliability. B. Timeliness. C. Neutrality. D. Relevance

A. Reliability is not a qualitative characteristic of useful accounting information. B. Timeliness is an enhancing qualitative characteristic of useful accounting information. Information is timely when it is available in time to influence decisions. C. Neutrality is an aspect of the fundamental qualitative characteristic of faithful representation. Information is neutral if it is unbiased in its selection and presentation. D. *Correct Answer* Relevance is a fundamental qualitative characteristic of useful accounting information. Relevant information is able to make a difference in user decisions. It must have predictive value, confirmatory value, or both. Something has predictive value if it can be used as an input in a predictive process.

A newly acquired plant asset is to be depreciated over its useful life. What is the basis for this accounting method? A. Economicentity assumption. B. Monetaryunit assumption. C. Materiality. D. Goingconcern assumption.

A. The economicentity assumption provides that economic activity can be identified with a particular unit of accountability. B. The monetaryunit assumption provides that all transactions and events can be measured in terms of a common denominator, for instance, the dollar. C. Information is material if its omission or misstatement can influence user decisions based on a specific entity's financial information. Thus, it is an entityspecific aspect of relevance. The materiality concept implies that items of insignificant value can be expensed rather than capitalized and depreciated or amortized. D. *Correct Answer* A basic feature of financial accounting is that the business entity is assumed to be a going concern in the absence of evidence to the contrary. The goingconcern concept is based on the empirical observation that many entities have indefinite lives. The reporting entity is assumed to have a life long enough to fulfill its objectives and commitments and therefore to depreciate wasting assets over their useful lives.

Which of the following assumptions means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis? A. Going concern. B. Periodicity. C. Monetary unit. D. Economic entity

A. The goingconcern assumption is that an entity has the ability to continue functioning as a business entity indefinitely. B. Preparing financial statements periodically ensures the timeliness of information. C. *Correct Answer* The monetaryunit assumption provides that all transactions and events can be measured in terms of a common denominator, for instance, a monetary unit. Accounting records are kept in terms of money. Using money as the unit of measure is the best way of providing economic information to users of financial statements. Also, the changing purchasing power of the monetary unit is assumed not to be significant. D. The economic entity assumption is that every business is an entity separate from its owners

Under SFAC No. 6, Elements of Financial Statements, interrelated elements of financial statements include Distributions to Owners Notes to Financial Statements A. Yes Yes B. Yes No C. No Yes D. No No

A. The notes to financial statements supplement and amplify the information contained in the statements; they are not directly related to measuring the performance and status of an enterprise. B. *Correct Answer* The elements of financial statements directly related to measuring the performance and status of business enterprises and nonbusiness organizations are assets, liabilities, equity of a business or net assets of a nonbusiness organization, revenues, expenses, gains, and losses. The elements of investments by owners, distributions to owners, and comprehensive income relate only to business enterprises. Information disclosed in notes or parenthetically on the face of financial statements amplifies or explains information recognized in the financial statements. C. Distributions to owners are directly related to measuring the performance and status of a business enterprise. The notes to financial statements supplement and amplify the information contained in the statements; they are not directly related to measuring the performance and status of a business enterprise. D. Distributions to owners are directly related to measuring the performance and status of a business enterprise. The notes to financial statements supplement and amplify the information contained in the statements; they are not directly related to measuring the performance and status of a business enterprise.

Which of the following bases is the best indication that rental revenue should be recognized as realized and earned? A. The collection of cash. B. The passage of time. C. The signing of the rental contract. D. Production and delivery

A. The time at which some or all of the rental period has passed represents the moment at which the revenue is realized and earned. B. *Correct Answer* Revenues should be recognized when they are realized or realizable and earned. The most common time at which these two conditions are met is when the product or merchandise is delivered or services are rendered to customers. Rental revenue should be recognized evenly over the period of time during which the asset is being rented. C. The time at which some or all of the rental period has passed represents the moment at which the revenue is realized and earned. D. The time at which some or all of the rental period has passed represents the moment at which the revenue is realized and earned.

According to the FASB's conceptual framework, the quality of information that enables users to identify similarities in and differences between two sets of economic phenomena is A. Conservatism. B. Neutrality. C. Matching. D. Comparability.

A. Under the conservatism constraint, when alternative accounting methods are appropriate, the one having the less favorable effect on net income and total assets is preferable. However, conservatism does not permit a deliberate understatement of total assets and net income. Furthermore, SFAC 5 describes "a general tendency to emphasize purchase and sale transactions and to apply conservative procedures in accounting recognition." B. Useful information faithfully represents economic events. A representation is perfectly faithful if it is (1) complete (containing what is needed for user understanding), (2) neutral (unbiased in its selection or presentation), and (3) free from error (but not necessarily perfectly accurate). C. Matching associates cause and effect, for example, recognition in the same period of revenues and the expenses incurred to produce them. D. *Correct Answer* Comparability is an enhancing qualitative characteristic. Information should be comparable with similar information for (1) other entities and (2) the same entity for another period or date. Thus, comparability allows users to understand similarities and differences.

According to the FASB conceptual framework, for financial reporting to be useful, it must A. Be in accordance with generally accepted accounting principles. B. Provide information useful for making business and investment decisions. C. Be understandable to those who have a limited knowledge of business activities D. Directly measure the value of the entity being reported on.

A. Unusual circumstances may permit a departure from GAAP. In such circumstances, the financial information is considered useful if it is relevant and faithfully represented. B. *Correct Answer* The objective of generalpurpose financial reporting is to report financial information that is useful in making decisions about providing resources to the reporting entity. This information must have of the fundamental qualitative characteristics of relevance and faithful representation. C. Financial information should be readily understandable by reasonably knowledgeable and diligent users but should not be excluded because of its complexity. But understandable information may not be useful. D. Some financial information is measured at historical cost and not at fair value. For example, items of property, plant, and equipment are measured at historical cost adjusted subsequently for depreciation. Accordingly, financial information cannot directly measure the value of the entity being reported on

Which of the following characteristics relates to both accounting relevance and faithful representation? A. Verifiability. B. Timeliness. C. Comparability. D. All of the answers are correct

A. Verifiability is an enhancing qualitative characteristic. Information is verifiable (directly or indirectly) if knowledgeable and independent observers can reach a consensus (but not necessarily unanimity) that it is faithfully represented. B. Timeliness is an enhancing qualitative characteristic. Information is timely when it is available in time to influence decisions. C. Comparability is an an enhancing qualitative characteristic. It is the quality of information that enables users to identify similarities in and differences among items. D. *Correct Answer* Verifiability, timeliness, comparability, and understandability are qualitative characteristics that enhance the relevance and faithful representation of accounting information.