Basic Theory and Financial Reporting Flashcards
1
Q
- What are the Statements of Financial Accounting
Concepts intended to establish?
a. Generally accepted accounting principles in financial
reporting by business enterprises.
b. The meaning of “Present fairly in accordance with
generally accepted accounting principles.”
c. The objectives and concepts for use in developing
standards of financial accounting and reporting.
d. The hierarchy of sources of generally accepted
accounting principles.
A
- (c) The Statements of Financial Accounting Concepts
(SFAC) were issued to establish a framework from which
financial
accounting and reporting standards could be
developed. The SFAC provide the theory behind accounting
and reporting and provide guidance when no GAAP exists.
The SFAC are not included
as GAAP.
2
Q
- According to the FASB conceptual framework, the
objectives
of financial reporting for business enterprises are
based on
a. Generally accepted accounting principles.
b. Reporting for regulators.
c. The need for conservatism.
d. The needs of the users of the information.
A
- (d) Per SFAC 8, the objectives of financial reporting focus
on providing present and potential investors and creditors with
information useful in making investment decisions. Financial
statement users do not have the authority to prescribe the data
they desire. Therefore, they must rely on external financial
reporting to satisfy their information needs, and the objectives
must be based on the needs of those users.
3
Q
- According to the FASB conceptual framework, the relevance
of providing information in financial statements is
subject to the constraint of
a. Comparability.
b. Cost-benefit.
c. Reliability.
d. Faithful representation.
A
- (b) The FASB conceptual framework has identified the costbenefit
constraint to the relevance of providing financial reports.
Information is not disclosed if the costs of disclosure outweigh
the benefits of providing the information. Comparability
is an
enhancing qualitative characteristic. Reliability is no longer part
of the conceptual framework according to SFAC 8. Faithful
representation is a fundamental qualitative characteristic.
4
Q
- The enhancing qualitative characteristics of financial
reporting
are
a. Relevance, reliability, and faithful representation.
b. Cost-benefit and materiality.
c. Comparability, verifiability, timeliness, and
understandability.
d. Completeness, neutrality, and freedom from error.
A
- (c) The enhancing qualitative characteristics
of financial reporting are comparability (including
consistency), verifiability, timeliness, and understandability.
Answer (a) is incorrect because
relevance and faithful
representation are fundamental qualitative characteristics
of financial information. Reliability is no longer listed as
a fundamental quality. Answer (b) is incorrect because
cost-benefit is a constraint, and materiality is a threshold
for reporting useful information. Answer (d) is incorrect
because completeness, neutrality, and freedom from error
are characteristics
of faithful representation, a fundamental
qualitative characteristic.
5
Q
5. According to Statements of Financial Accounting Concepts, neutrality is an ingredient of Faithful representation Relevance a. Yes Yes b. Yes No c. No Yes d. No No
A
- (b) SFAC 8 defines neutrality as the quality of information
which requires freedom from bias toward a predetermined
result. Unbiased information would always be more
faithfully represented than biased information. Other components
of faithful representation include information to be
verifiable
and free from error. Neutrality is not an ingredient
of relevance
because relevance requires information to have
predictive value and confirmatory value, or both
6
Q
- According to the FASB conceptual framework, which
of the following is an enhancing quality that relates to both
relevance and faithful representation?
a. Comparability.
b. Confirmatory value.
c. Predictive value.
d. Freedom from error.
A
- (a) Per SFAC 8, comparability is an enhancing quality of
financial reporting which relates to both relevance and faithful
representation. Confirmatory value and predictive value only
relate to relevance. Freedom from error only relates to faithful
representation.
7
Q
- According to the FASB conceptual framework, the process
of reporting an item in the financial statements of an entity is
a. Allocation.
b. Matching.
c. Realization.
d. Recognition.
A
- (d) Per SFAC 5, recognition is the process of formally
recording or incorporating an item into the financial statements
as an asset, liability, revenue, expense, or the like. According
to SFAC 6, allocation is the process of assigning or distributing
an amount according to a plan or formula, matching is the
simultaneous
recognition of revenues with expenses that
are related directly or jointly to the same transactions or
events, and realization
is the process of converting noncash
resources and rights into money.
8
Q
- Under FASB Statement of Financial Accounting Concepts
5, which of the following items would cause earnings
to differ from comprehensive income for an enterprise in an
industry
not having specialized accounting principles?
a. Unrealized loss on investments classified as availablefor-
sale securities.
b. Unrealized loss on investments classified as trading
securities.
c. Loss on exchange of similar assets.
d. Loss on exchange of dissimilar assets.
A
- (a) Per SFAC 5, earnings and comprehensive income
have the same broad components—revenues, expenses, gains,
and losses—but are not the same because certain classes of
gains and losses are excluded from earnings. Changes in
market values of investments in marketable equity securities
classified as available-for-sale securities are included in
comprehensive income,
but are excluded from earnings until
realized. Answers
(b), (c), and (d) are incorrect because
they would be included in both earnings and comprehensive
income. Note that unrealized gains and losses on marketable equity securities classified
as trading securities are included in
earnings. This treatment
is in accordance with SFAS 115.
9
Q
- Under FASB Statement of Financial Accounting Concepts
5, comprehensive income excludes changes in equity resulting
from which of the following?
a. Loss from discontinued operations.
b. Prior period error correction.
c. Dividends paid to stockholders.
d. Unrealized loss on securities classified as availablefor-
sale.
A
- (c) Per SFAC 6, comprehensive income includes all
changes in equity during a period except those resulting from
investments by owners and distributions to owners. Dividends
paid to stockholders is a change in equity resulting from a
distribution
to owners, so it is excluded from comprehensive
income. Answers (a), (b), and (d) are all included in
comprehensive income
because they are changes in equity, but
are not investments
by, or distributions to, owners.
10
Q
- The fundamental qualitative characteristic of faithful
representation
has the components of
a. Predictive value and confirmatory value.
b. Comparability, consistency, and confirmatory value.
c. Understandability, predictive value, and reliability.
d. Completeness, neutrality, and freedom from error
A
- (d) The fundamental qualitative characteristic of faithful
representation has the components of completeness, neutrality,
and freedom from error. Answer (a) is incorrect because
predictive
value and confirmatory value are the components of
relevance.
Answer (b) is incorrect because comparability and
consistency
are enhancing characteristics, and confirmatory
value is a component of relevance. Answer (c) is incorrect,
because understandability
is an enhancing characteristic,
predictive value is a component of relevance, and reliability is
no longer a characteristic
in the concept statements.
11
Q
- According to the FASB conceptual framework, which of
the following statements conforms to the realization concept?
a. Equipment depreciat was assigned to a production
department and then to product unit costs.
b. Depreciated equipment was sold in exchange for a
note receivable.
c. Cash was collected on accounts receivable.
d. Product unit costs were assigned to cost of goods sold
when the units were sold.
A
- (b) According to SFAC 6, realization is the process of
converting noncash resources and rights into money through
the sale of assets for cash or claims to cash. When equipment
is sold for a note receivable, money is realized since a note
qualifies as a claim to cash. Answers (a) and (d) relate to cost
allocation. Answer (c) is incorrect because accounts receivable
represents a claim to cash. Realization occurs at the time of
sale rather than when cash is collected.
12
Q
12. What is the underlying concept that supports estimating a fixed asset impairment charge? a. Substance over form. b. Consistency. c. Matching. d. Faithful representation.
A
- (d) An estimate of an impairment charge to a fixed asset
can only be a faithful representation if the entity has applied
impairment
rules properly, disclosed the process of arriving at
the impairment estimate and disclosed any uncertainties that
affect the impairment estimate. Assuming the above is true,
and no other estimate is better than the derived estimate, then
the estimate
is comprised of the best available information.
Therefore, it is a faithful representation.
13
Q
13. What is the concept that supports the issuance of interim reports? a. Relevance. b. Materiality. c. Consistency. d. Faithful representation.
A
- (a) Relevant financial information is capable of making
a difference if it has predictive value, confirmatory, value,
or both. Predictive value requires information to be used to
predict future outcomes. Confirmatory value requires that
information either confirm or change prior expectations. An
interim report provides
both predictive value and confirmatory
value because it provides a basis to forecast future earnings
and it provides feedback
about prior performance expectations.
Therefore, interim reporting is relevant.
14
Q
- FASB’s conceptual framework explains both financial and
physical capital maintenance concepts. Which capital maintenance
concept is applied to currently reported net income, and
which is applied to comprehensive income?
Currently
reported net income
Comprehensive
income
a. Financial capital Physical capital
b. Physical capital Physical capital
c. Financial capital Financial capital
d. Physical capital Financial capital
A
- (c) Per SFAC 6, the major difference between financial
and physical capital maintenance is related to the effects of
price changes on assets held and liabilities owed during a
period. The financial capital concept is applied in current
GAAP. Under this concept, the effects of the price changes
described above are considered “holding gains and losses,” and
are included in computing
return on capital. Comprehensive
income, which is described
in SFAC 5, is “the change in equity
of a business enterprise
during a period from transactions and
other events and circumstances from nonowner sources.” It
is also a measure of return on financial capital. The concept
of physical capital maintenance seeks to measure the effects of price changes that are not currently captured under GAAP
(e.g., replacement costs of nonmonetary assets). Under this
concept, holding gains and losses are considered “capital
maintenance adjustments” which would be included directly in
equity and excluded from return on capital
15
Q
- According to the FASB conceptual framework, an entity’s
revenue may result from
a. A decrease in an asset from primary operations.
b. An increase in an asset from incidental transactions.
c. An increase in a liability from incidental
transactions.
d. A decrease in a liability from primary operations.
A
equity and excluded from return on capital.
15. (d) Per SFAC 6, revenues are inflows of assets or settlements
of liabilities, or both, during a period as a result
of an entity’s
major or primary operations. Two essential
characteristics of revenues are that revenues (1) arise from a
company’s primary earnings activities and (2) are recurring or
continuing in nature. Therefore, answer (d) is correct because
it meets the above criteria.
Answers (b) and (c) are incorrect
because they result from incidental transactions. Answer (a) is
incorrect because a decrease
of an asset is not a revenue.
16
Q
- According to the FASB 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
- (d) Per SFAC 6, the common quality shared by all
assets is “service potential” or “future economic benefit.” Per
SFAC 6, assets commonly have other distinguishing features,
such as being
legally enforceable, tangible or acquired at a
cost. These features,
however, are not essential characteristics
of assets.
17
Q
- According to the FASB conceptual framework, which
of the following attributes would not be used to measure
inventory?
a. Historical cost.
b. Replacement cost.
c. Net realizable value.
d. Present value of future cash flows.
A
- (d) Per SFAC 5, five different attributes are used to
measure assets and liabilities in present practice: historical
cost, current (replacement) cost, current market value, net
realizable value, and present value of future cash flows. Three
of these (historical
cost, replacement cost, and net realizable
value) are used in measuring inventory at lower of cost or
market. Present value of future cash flows is not used to
measure inventory.
18
Q
- According to SFAC 7, Using Cash Flow Information and
Present Value in Accounting Measurements, the most relevant
measurement of an entity’s liabilities at initial recognition and
fresh-start measurements should always reflect
a. The expectations of the entity’s management.
b. Historical cost.
c. The credit standing of the entity.
d. The single most-likely minimum or maximum
possible amount.
A
- (c) The most relevant measure of a liability always
reflects
the credit standing of the entity obligated to pay,
according to SFAC 7. Those who hold the entity’s obligations
as assets incorporate the entity’s credit standing in determining
the prices they are willing to pay.
19
Q
- Which of the following is not covered by SFAC 7, Using
Cash Flow Information and Present Value in Accounting
Measurements?
a. Measurements at initial recognition.
b. Interest method of amortization.
c. Expected cash flow approach.
d. Determining when fresh-start measurements are
appropriate
A
- (d) SFAC 7 provides a framework for using future
cash flows as the basis for accounting measurements at
initial recognition
or fresh-start measurements and for the
interest method of amortization. FASB limited SFAC 7
to measurement issues (how to measure) and chose not
to address recognition questions
(when to measure).
SFAC 7 introduces the expected cash flow approach, which
differs from the traditional approach by focusing on explicit
assumptions about the range of possible estimated cash flows
and their respective probabilities
20
Q
- In calculating present value in a situation with a range of
possible outcomes all discounted using the same interest rate,
the expected present value would be
a. The most-likely outcome.
b. The maximum outcome.
c. The minimum outcome.
d. The sum of probability-weighted present values.
A
- (d) The expected cash flow approach uses all expectations
about possible cash flows in developing a measurement, rather
than just the single most-likely cash flow. By incorporating a
range of possible outcomes (with their respective timing differences),
the expected cash flow approach accommodates the use
of present value techniques when the timing of cash flows is
uncertain.
Thus, the expected cash flow is likely to provide a
better estimate of fair value than the minimum, most-likely, or
maximum
taken alone. According to SFAC 7, expected present
value refers to the sum of probability-weighted present values
in a range of estimated cash flows, all discounted using the
same interest
rate convention.
21
Q
- A cash flow of $200,000 may be received by Lydia Nickels,
Inc. in one year, two years, or three years, with probabilities of
20%, 50%, and 30%, respectively. The rate of interest on default
risk-free investments is 5%. The present value factors are
PV of 1, at 5%, for 1 year is .95238
PV of 1, at 5%, for 2 years is .90703
PV of 1, at 5%, for 3 years is .86384
What is the expected present value of Lydia Nickels’ cash flow
(in whole dollars)?
a. $181,406
b. $180,628
c. $90,703
d. $89,925
A
21. (b) The computation of expected present value using a single interest rate is as follows: PV of $200,000 in one year at 5% Probability $190,476 20% $38,095 PV of $200,000 in two years at 5% Probability $181,406 50% 90,703 PV of $200,000 in three years at 5% Probability $172,768 30% 51,830 $180,628 According to SFAC 7, expected present value refers to the sum of probability-weighted present values in a range of estimated cash flows, all discounted using the same interest rate convention.
22
Q
- Which of the following statements regarding interest
methods
of allocations is not true?
a. The term “interest methods of allocation” refers both
to the convention for periodic reporting and to the
several approaches to dealing with changes in estimated
future cash flows.
b. Interest methods of allocation are reporting conventions
that use present value techniques in the absence
of a fresh-start measurement to compute changes in
the carrying amount of an asset or liability from one
period to the next.
c. Interest methods of allocation are grounded in the notion
of current cost.
d. Holding gains and losses are generally excluded from
allocation systems.
A
- (c) Like depreciation and amortization conventions,
interest methods are grounded in notions of historical cost, not
current cost.
23
Q
- Which of the following is not an objective of using
present value in accounting measurements?
a. To capture the value of an asset or a liability in the
context
of a particular entity.
b. To estimate fair value.
c. To capture the economic difference between sets of
future
cash flows.
d. To capture the elements that taken together would
comprise a market price if one existed.
A
- (a) According to SFAC 7, the objective of using present
value in an accounting measurement is to capture, to the
extent possible, the economic difference between sets of
future cash flows. The objective of present value, when used
in accounting measurements at initial recognition and freshstart
measurements,
is to estimate fair value. Stated differently,
present value should attempt to capture the elements that taken
together would comprise a market price, if one existed, that
is fair value. Value-in-use and entity-specific measurements
attempt to capture
the value of an asset or liability in the
context of a particular entity. An entity-specific measurement
substitutes the entity’s assumptions for those that marketplace
participants would make.
24
Q
- On December 31, year 1, Brooks Co. decided to end
operations
and dispose of its assets within three months.
At December 31, year 1, the net realizable value of the
equipment was below historical cost. What is the appropriate
measurement basis for equipment included in Brooks’
December 31, year 1 balance sheet?
a. Historical cost.
b. Current reproduction cost.
c. Net realizable value.
d. Current replacement cost.
A
- (c) The Codification provides guidance on the determination
of gain or loss on disposal of a component of
a business.
According to this guidance, such determination
should be based on estimates of the net realizable value of
the component. Since Brooks Co. plans to discontinue its
entire operations, the appropriate measurement basis for its
equipment is net realizable value. Historical cost and current
reproduction and replacement costs are not appropriate
measurement bases for assets once an entity has decided to
discontinue its operations because these amounts do not reflect
the entity’s probable future benefit, which is a characteristic of
assets per SFAC 6.
