1.8 Recognition and Measurement Concepts

Question 1

Define recognition

Answer 1

is the formal recording or incorporation of an item in the financial statements as an asset, liability, revenue, expense, gain, loss, etc.

Question 2

What is the recognition criteria designed to determine?

Answer 2

determine whether and when items are incorporated into the financial statements, either initially or as changes in existing items

Question 3

Identify the 4 fundamental recognition criteria:

HINT: Recognition Defines Measurable Relevance and Reliability

Answer 3

• The item must meet the definition of an element of financial statements
• It must have a relevant attribute MEASURABLE with sufficient reliability
• The information must be RELEVANT. It must be capable of making a difference in user decisions.
• The information must be RELIABLE. It must be representationally faithful, verifiable, and neutral.

Question 4

Identify the constraint and threshold all items are subject to before being incorporated into the financial statements

Answer 4

• pervasive cost constraint

- materiality threshold

Question 5

When are revenues and gains recognized according to the revenue recognition principle? (2)

Answer 5

• when realized or realizable

- when earned

Question 6

How are revenues and gains measured according to the revenue recognition principle?

Answer 6

by the exchange prices of the assets or liabilities involved

Question 7

When are revenues and gains REALIZED according to the revenue recognition principle?

Answer 7

when goods or services have been exchanged for cash or claims to cash

Question 8

When are revenues and gains REALIZABLE according to the revenue recognition principle?

Answer 8

when goods or services have been exchanged for assets that are readily convertible into cash or claims to cash

Question 9

Identify 2 elements that readily convertible assets must have:

Answer 9

• Interchangeable (fungible) units and
• Quoted prices available in an active market that can rapidly absorb the quantity held by the entity without a significant effect on the price

Question 10

When are revenues considered EARNED according to the revenue recognition principle? (2)

Answer 10

• when the earning process has been substantially completed

- and the entity is entitled to the resulting benefits or revenues

Question 11

Are expenses subject to the realization criterion? Explain

Answer 11

No - because of the conservatism constraint

Question 12

When are expenses and losses recognized according to expense recognition criteria? (2)

Answer 12

• a consumption of economic benefits occurs or

- the ability of existing assets to provide future benefits is impaired

Question 13

Provide an example of an expense or loss being recognized when a liability has been incurred or increased without the receipt of corresponding benefits

Answer 13

A probable and reasonably estimable contingent loss

Question 14

Identify the 3 expense recognition principles:

Answer 14

• associating cause and effect (aka matching)
• systematic and rational allocation
• immediate recognition

Question 15

Define “associating cause and effect aka matching”

Answer 15

the simultaneous recognition of revenues and expenses that directly result from the same transactions or other events.

Question 16

Provide 2 examples of matching or associating cause and effect as an expense recognition principle

Answer 16

• sales revenue and the related cost of goods sold, shipping expenses, and selling expenses
• estimated bad debt expense and the related credit sales

Question 17

Define “immediate recognition” as an expense recognition principle

Answer 17

• applies when costs cannot be directly or feasibly related to specific revenues
• benefits of costs are used up in the period in which they are incurred
• periods to which they relate may not be feasibly determinable

Question 18

Provide examples of costs that are immediately recognized (4)

Answer 18

• R&D costs
• write-offs of worthless assets
• utilities expense
• employees’ monthly salaries

Question 19

Identify the 5 measurement attributes

HINT: HCCNP

Answer 19

• historical cost
• current (replacement) cost
• current market value (exit value)
• net realizable value (NRV)
• present value

Question 20

What might current or replacement cost be used for? (2)

Answer 20

• to measure LIFO and retail method inventories

Question 21

Define current (replacement) cost

Answer 21

the amount of cash that would have to be paid for a current acquisition of the same or an equivalent asset

Question 22

Define current market value (exit value)

Answer 22

cash or equivalent realizable by selling an asset in an orderly liquidation (not in a forced sale)

Question 23

When is the current market value (exit value) used?

Answer 23

used to measure some marketable securities, e.g., those held by investment entities or assets expected to be sold at below their carrying amount (lower of cost or market)

Question 24

Define net realizable value or NRV

Answer 24

the cash or equivalent expected to be received for an asset in the due course of business, minus the costs of completion and sale

Question 25

When is net realizable value or NRV normally used?

Answer 25

to measure short-term receivables and some inventories.

Question 26

What is net settlement value?

Answer 26

• the relevant attribute for trade payables and warranty liabilities
• the sum of the undiscounted amount of cash (or equivalent) expected to be paid to liquidate an obligation in the ordinary course of business

Question 27

Define present value

Answer 27

• in theory the most relevant method of measurement because it incorporates time value of money concepts

Question 28

How is present value or PV calculated?

Answer 28

• choose an appropriate discount rate or interest rate

- identify the timing and amount of future cash flows

Question 29

What is PV currently mainly used for in relation to measurement attributes?

Answer 29

non-current receivables and payables