61 STUDY GUIDE

Question 2

2117.26

2117.26

Answer 2

Question 3

2117.01

Question #300164

Answer 3

The concept of adequate disclosure is firmly established as an underlying principle of financial reporting. The CPA’s responsibility for disclosure extends to the inclusion of all information believed to be relevant to financial statement users who have a reasonable knowledge of accounting and business matters. The user must not be burdened with information that is irrelevant in terms of quantity and detail nor must the user be misled or left uninformed on important matters.

Question 4

2117.02

Question #300164

Answer 4

Disclosure of financial information about an enterprise is accomplished through a variety of means, including the financial statements themselves, the auditor’s report, discussions in the annual report other than the financial statements, press releases, and others. Of particular interest in the preparation of financial statements are the following types of disclosures:

Form and content in the body of the financial statements (including parenthetical information, information shown “short,” and classifications of information)
Notes to the financial statement and supplemental information
Information presented in the body of the financial statements has been illustrated in the preceding example. Supplemental disclosures and notes to the financial statements are discussed in the following paragraphs.

Question 5

2117.03

Question #300164

Answer 5

Notes to the financial statements and supplemental disclosures are difficult to categorize because appropriate disclosure in any particular set of circumstances is dependent on the particular characteristics of each financial reporting situation. The following chart shows the types of footnotes and supplemental disclosures that are frequently encountered.

Question 6

2117.04

Answer 6

Information about accounting policies adopted by a reporting enterprise is an integral part of the financial statements and is necessary in interpreting other financial statement data. Accordingly, when financial statements are issued purporting to present fairly the financial position, cash flows, and results of operations in accordance with generally accepted accounting principles, a description of all significant accounting policies of the reporting enterprise is required. This reporting requirement extends to not-for-profit enterprises. It does not apply to unaudited financial statements issued between annual reporting dates if the reporting enterprise has not changed policies since the end of the latest fiscal year.

Question 7

2117.05

Answer 7

The following statements describe the form and content of accounting policy disclosure:

a. The disclosure encompasses important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods.
b. The disclosure encompasses principles and methods that involve the selection from among existing acceptable alternatives.
c. Principles and methods peculiar to the industry are disclosed, even if the principles and methods are predominantly followed in that industry.
d. Unusual or innovative applications of generally accepted accounting principles are disclosed.
e. Policy disclosure is particularly useful if presented in a separate summary schedule, preceding the notes to the financial statements or as the first note. This should be appropriately identified (e.g., “Summary of Significant Accounting Policies”).
f. Policy disclosure in a summary schedule should not duplicate information presented elsewhere in the financial statements.
g. In some cases, policy disclosure may need to be cross-referenced to information disclosed in other parts of the financial statements (e.g., other notes).

Question 8

2117.06

Answer 8

Examples of accounting principles and methods for which disclosure of policy is frequently made include, but are not limited to, the following:

Depreciation methods
Consolidation basis
Interperiod tax allocation
Inventory pricing
Revenue recognition methods

Question 9

2117.07

Answer 9

One of the purposes of financial statements is to provide information to help users to predict the reporting entity’s future cash flows and results of operations. This assessment depends, to some degree, on the users’ knowledge and assessment of the risks and uncertainties involving the entity’s operations. Disclosure of these risks and uncertainties is a critical component of the user’s process of evaluating these variables. The FASB addresses the disclosures required to facilitate a user’s evaluation of an entity’s risks and uncertainties.

Question 10

2117.08

Answer 10

An important element of the topic of risks and uncertainties is selectivity. Selectivity involves the specified criteria that serve to screen the risks and uncertainties encountered by every entity. The objective is to restrict required disclosures to matters that are significant to that specific entity.

Question 11

2117.09

Answer 11

The disclosures discussed in this section focus on risks and uncertainties that could significantly affect amounts reported in the near-term. Near-term is defined as a period not to exceed one year from the date of the financial statements.

Question 12

2117.10

Answer 12

The types of risks and uncertainties discussed in this section are:

the nature of the entity’s operations,
the use of estimates in the preparation of the entity’s financial statements, and
significant concentrations in certain aspects of the entity’s operations.

Question 13

2117.13

Answer 13

Estimates are a necessary part of the preparation of financial statements. It is necessary to explicitly communicate to the users of the financial statements that estimates have been used and that many of the amounts reported are approximations rather than exact amounts. This understanding should help users to make better decisions.

Question 14

2117.14

Answer 14

The financial statements must include an explanation that the preparation of the statements requires the use of management’s estimates in conformity with GAAP. The statements must also disclose certain significant estimates.

Question 15

2117.15

Answer 15

Certain significant estimates are those estimates involving a situation where it is reasonably possible that the estimate will change in the term and the effect of the change will be material.

Question 16

2117.16

Answer 16

Disclosure of these significant estimates must be made when the following conditions are present:

a. It is at least reasonably possible that the estimate of the effect on the financial statements will change in the near term due to one or more future confirming events (reasonably possible is a chance more than remote but less than likely).
b. The effect of the change would be material.

Question 17

2117.17

Answer 17

The disclosure must include the nature of the uncertainty and an indication that it is at least reasonably possible that this change in the estimate will occur in the near term.

Question 18

2117.20

Answer 18

Vulnerability to concentrations refers to risk due to a lack of diversification. Disclosure of such risk must be made if, based on management’s information, the following criteria are met:

a. the concentration exists at the date of the financial statements,
b. the concentration make the entity vulnerable to the risk of a near-term severe impact, and
c. it is at least reasonably possible that the events that could cause the severe impact will occur in the near term.

Question 19

2117.21

Answer 19

A severe impact is defined as a significant financially disruptive effect on the normal functioning of an entity. Severe impact matters are matters that are more than material but less than catastrophic.

Question 20

2117.22

Answer 20

Disclosure must be made of concentrations known to management rather than based on knowledge of which management could reasonably be expected to know.

Question 21

2117.23

Answer 21

Examples of categories of concentrations include:

• concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor, or contributor,
• concentrations in revenue from particular products, services, or fund-raising events,
• concentrations in the available sources of supply of materials, labor, or services or of licenses or other rights used in the entity’s operations, and
• concentrations in the market or geographic area in which an entity conducts its operations.

Question 22

2117.25

Answer 22

The FASB, when considering note disclosure, considers recognition, measurement, and presentation issues as well as other concepts such as objectives of financial reporting and qualitative characteristics of useful financial information. However, the FASB must also consider four constraints/limitations related to required information:

1. Relevance: Disclosure is based upon relevance, not entity-specific materiality. The FASB wants to avoid overly prescriptive disclosures.
2. The cost constraint: The cost constraint applies to disclosure. The FASB has an expectation that financial statement users have awareness of accounting rules, policies, and regulations. Thus, common knowledge can be excluded from the notes. Disclosure should include details of measurement if alternatives exist, methods not obvious to the user, or methods if changed since prior reporting. The FASB attempts to avoid requirements of other authoritative bodies such as the SEC (Securities and Exchange Commission). Furthermore, technology may change the FASB’s opinion over time.
3. Potential adverse consequences: The FASB will consider, apart from the cost constraint, potential adverse consequences. Disclosure can have both beneficial and adverse consequences.
4. Future-oriented information: Some types of future-oriented information are already prepared (e.g., budgets, forecasts, or SEC-required “forward-looking” information), so the cost constraint would not apply to these items. Although the SEC provides protection for issuers regarding SEC-required information, that protection does not extend beyond SEC filings, potentially resulting in negative impacts (e.g., litigation) for entities providing information based upon predictions, projections, and forecasts about uncertain or unknown future events. Therefore, the FASB does not require entities to disclose predictions of future outcomes that could result in negative consequences. However, two types of forward-looking information are useful and should be provided: (1) estimates and assumptions, and (2) management’s existing plans and strategies for management-controlled matters.

• Estimates and assumptions: Many of these inputs are related to fair value measurements that are based upon existing conditions and are important for faithful representation. Estimates and assumptions such as salvage value and useful asset life, although forward-looking, are also important for faithful representation. The FASB will consider required disclosures relating to these items. However, items such as predictions of future sales transactions are not based upon past events and, mostly, would be considered inappropriate for required disclosure.
• Management’s existing plans and strategies: Disclosure may be appropriate if it affects the presentation, recognition, or measurement of line items. However, disclosure of such items may result in negative consequences and is rarely helpful for explanations of financial statement line items.

Question 23

2117.26

Answer 23

Question 24

2117.26

Answer 24

Question 25

2117.26

Answer 25

Question 26

2117.26

Answer 26

Question 27

2117.18

Answer 27

Examples of items that might require disclosure under this topic include:

a. inventory subject to rapid technological obsolescence,
b. specialized equipment subject to technological obsolescence,
c. valuation allowances for deferred tax assets based on future taxable income,
d. capitalized motion picture film production costs,
e. capitalized computer software costs,
f. deferred policy acquisition costs of insurance entities,
g. valuation allowances for commercial and real estate loans,
h. environmental remediation-related obligations,
i. contingent liabilities for obligations of other entities,
j. amounts reported for long-term obligations, such as amounts reported for pension and postemployment benefits,
k. estimated net proceeds recoverable, the provisions for expected loss to be incurred, or both, on disposition of a business or assets, and
l. amounts reported for long-term contracts.

Question 28

2117.19

Answer 28

In determining whether disclosure is required about an estimate of useful life of an intangible asset, determination of whether the effect would be material is made based on either the individual asset or by major asset class as it refers to either a change in the useful life or a change in the expected likelihood of renewal or extension of an intangible asset.

Question 29

Past events and current conditions potentially impacting the entity’s future cash flow include which of the following?

Related party transactions

Segment reporting

Timing of asset cash flows

Subsequent events

Question #302520

Answer 29

Subsequent events

Examples of past events and current conditions potentially impacting the entity’s future line items and cash flows but which have not yet been incorporated into financial statement line items include existing or potential litigation; suspected or known statute, judicial, regulatory, or contract violations; unrecognized existing commitments expected to be recognized in the future; events where significant uncertainty led to the decision to not recognize the event; and subsequent events. Items not necessarily impacting line items that may require disclosure include dependency on one or a few customers or suppliers for profitability, input or output market volatility, uncertainty regarding an entity’s access to markets for inputs or outputs or ability to maintain a qualified workforce, and other significant specific entity risk.

Segment reporting and related party transactions are considered to be reporting entity disclosures, and the timing of asset cash flows is considered a financial statement line item explanation.

error_outline First Time Score
42% answered this question correctly their first time.

Video Links
FAR 1A7 - Notes to Financial Statements
FAR 1A7 - Notes to Financial Statements - Practice Questions

Relevant Terms
Conceptual Framework
Disclosure
Notes to Financial Statements

Reference
2117.26

Authorities
SFAC 8.8

Question 30

Numerous estimates are part of accrual accounting financial statements. Disclosures about these estimates are required in the notes to the financial statements. All but one of the following are correct statements about estimates disclosures; which statement is incorrect?

Certain significant estimates must be disclosed if there is a reasonable possibility that the estimate will change in the near term and the effect of the change will be material.

Determining whether the effect of a change in the useful life of an intangible asset will be material should be done either at the individual asset or major asset class level.

GAAP requires an explanation that the preparation of the financial statements requires the use of estimates made by management in conformance with GAAP.

Financial statement preparers can reasonably assume that users of financial statements recognize that estimates are necessary in preparing financial statements and therefore no explicit statement regarding estimates is necessary.

Question #302104

Question #302104

Answer 30

Financial statement preparers can reasonably assume that users of financial statements recognize that estimates are necessary in preparing financial statements and therefore no explicit statement regarding estimates is necessary.

Question #302104

GAAP requires the disclosure of the use of estimates in financial statements. Explicit communication in the notes to the financial statements about the use of estimates is necessary and should inform readers that many of the amounts reported are approximations, not exact amounts.

“Significant estimates” refers to estimates that have a reasonable possibility of changing in the near future and whose effect will be material—such items require disclosure in the notes to the financial statements. Whether disclosure is required for changes in intangible assets’ useful lives is based on determining if such changes will be material, and this determination needs to be done either at the individual asset or major asset class level.

error_outline First Time Score
74% answered this question correctly their first time.

Video Links
FAR 1A7 - Notes to Financial Statements
FAR 1A7 - Notes to Financial Statements - Practice Questions

Relevant Terms
Accounting Estimate
Accrual
Generally Accepted Accounting Principles (GAAP)
Notes to Financial Statements

Reference
2117.13
2117.14
2117.15
2117.19

Question 31

A transaction that is unusual in nature or infrequent in occurrence should be reported as:

a component of income from continuing operations, net of applicable income taxes.

nonoperating income or loss, but not net of applicable income taxes.

nonoperating income or loss, net of applicable income taxes.

a component of income from continuing operations, but not net of applicable income taxes.

Question #300830

Answer 31

a component of income from continuing operations, but not net of applicable income taxes.

These items should be included in the computation of net income from continuing operations prior to income tax expense.

error_outline First Time Score
21% answered this question correctly their first time.

Video Links
FAR 1A7 - Notes to Financial Statements
FAR 1A7 - Notes to Financial Statements - Practice Questions

Reference
2117.26

Authorities
FASB ASC 225-20-45-10

Question 32

When entities face risk due to a lack of diversification, they must include disclosures in the notes to the financial statements about “vulnerability to concentrations.” Which of the following is not a necessary criterion of a “vulnerability to concentrations”?

There is a reasonable possibility that the events resulting in a severe impact related to the concentration will occur in the near term.

The concentration makes the entity vulnerable to the risk of a severe impact in the near term.

The concentration exists at the date in the financial statements.

Severe impact events are those that are catastrophic.

Question #302067

Answer 32

Severe impact events are those that are catastrophic.

When firms lack diversification, they may be exposed to risks not faced by firms with adequate diversification. This is called “vulnerability to concentrations.” Such risks need to be disclosed in the notes to the financial statements when three conditions exist:

Such a concentration exists at the date of the financial statements.
The concentration makes the entity vulnerable to the risk of a near-term severe impact.
It is at least reasonably possible that the events that could cause the severe impact will occur in the near term.
When management’s information indicates that these three conditions exist, the firm must disclose it is “vulnerable to concentrations.”

The answer choice “severe impact events are those that are catastrophic” is not one of the conditions necessary to require disclosure. While a concentrated event may be catastrophic, it only meets the disclosure requirement if it is also vulnerable to concentration.

error_outline First Time Score
54% answered this question correctly their first time.

Video Links
FAR 1A7 - Notes to Financial Statements
FAR 1A7 - Notes to Financial Statements - Practice Questions

Relevant Terms
Notes to Financial Statements

Reference
2117.20
2117.21